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Equity Commonwealth - Quarter Report: 2010 September (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2010

 

OR

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 1-9317

 

COMMONWEALTH REIT

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland

 

04-6558834

(State or Other Jurisdiction of Incorporation or
Organization)

 

(IRS Employer Identification No.)

 

400 Centre Street, Newton, Massachusetts 02458

(Address of Principal Executive Offices)  (Zip Code)

 

617-332-3990

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check One):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of November 1, 2010: 72,138,686

 

 

 



Table of Contents

 

COMMONWEALTH REIT

 

FORM 10-Q

 

September 30, 2010

 

INDEX

 

 

 

 

Page

PART I

Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets — September 30, 2010 and December 31, 2009

 

1

 

 

 

 

 

Condensed Consolidated Statements of Income — Three and Nine Months Ended September 30, 2010 and 2009

 

2

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2010 and 2009

 

3

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

5

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

18

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

33

 

 

 

 

Item 4.

Controls and Procedures

 

35

 

 

 

 

 

Warning Concerning Forward Looking Statements

 

36

 

 

 

 

 

Statement Concerning Limited Liability

 

38

 

 

 

 

PART II

Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

39

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

39

 

 

 

 

Item 5.

Other Information

 

39

 

 

 

 

Item 6.

Exhibits

 

39

 

 

 

 

 

Signatures

 

41

 

References in this Form 10-Q to “we”, “us” and “our” refers to CommonWealth REIT and its consolidated subsidiaries, unless otherwise noted.  All share amounts in this Form 10-Q give effect to the reverse stock split that resulted in a one for four combination of our common shares effective July 1, 2010.

 



Table of Contents

 

PART I          Financial Information

 

Item 1.  Financial Statements

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Real estate properties:

 

 

 

 

 

Land

 

$

1,238,611

 

$

1,237,808

 

Buildings and improvements

 

5,150,677

 

5,085,873

 

 

 

6,389,288

 

6,323,681

 

Accumulated depreciation

 

(911,211

)

(884,421

)

 

 

5,478,077

 

5,439,260

 

Properties held for sale

 

8,297

 

8,263

 

Acquired real estate leases, net

 

179,357

 

166,453

 

Equity investments

 

173,721

 

158,822

 

Cash and cash equivalents

 

174,723

 

18,204

 

Restricted cash

 

7,075

 

11,662

 

Rents receivable, net of allowance for doubtful accounts of $12,415 and $10,945, respectively

 

198,899

 

194,358

 

Other assets, net

 

153,626

 

124,299

 

Total assets

 

$

6,373,775

 

$

6,121,321

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Revolving credit facility

 

$

 

$

110,000

 

Senior unsecured debt, net

 

2,474,116

 

2,258,466

 

Mortgage notes payable, net

 

352,575

 

624,184

 

Other liabilities related to properties held for sale

 

11

 

14

 

Accounts payable and accrued expenses

 

108,792

 

103,608

 

Acquired real estate lease obligations, net

 

43,513

 

47,348

 

Distributions payable

 

 

26,863

 

Rent collected in advance

 

32,418

 

30,366

 

Security deposits

 

22,903

 

23,097

 

Due to affiliates

 

25,602

 

8,309

 

Total liabilities

 

3,059,930

 

3,232,255

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred shares of beneficial interest, $0.01 par value:

 

 

 

 

 

50,000,000 shares authorized;

 

 

 

 

 

Series B preferred shares; 8 3/4% cumulative redeemable at par on or after September 12, 2007; 7,000,000 shares issued and outstanding, aggregate liquidation preference $175,000

 

169,079

 

169,079

 

Series C preferred shares; 7 1/8% cumulative redeemable at par on or after February 15, 2011; 6,000,000 shares issued and outstanding, aggregate liquidation preference $150,000

 

145,015

 

145,015

 

Series D preferred shares; 6 1/2% cumulative convertible; 15,180,000 shares issued and outstanding, aggregate liquidation preference $379,500

 

368,270

 

368,270

 

Common shares of beneficial interest, $0.01 par value:

 

 

 

 

 

350,000,000 shares authorized; 72,138,686 and 55,965,061 shares issued and outstanding, respectively

 

721

 

560

 

Additional paid in capital

 

3,354,771

 

2,925,845

 

Cumulative net income

 

2,350,033

 

2,236,928

 

Cumulative common distributions

 

(2,639,887

)

(2,576,582

)

Cumulative preferred distributions

 

(420,597

)

(382,596

)

Cumulative other comprehensive (loss) income

 

(13,560

)

2,547

 

Total shareholders’ equity

 

3,313,845

 

2,889,066

 

Total liabilities and shareholders’ equity

 

$

6,373,775

 

$

6,121,321

 

 

See accompanying notes

 

1



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

218,035

 

$

206,032

 

$

644,725

 

$

634,577

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

93,722

 

87,881

 

271,664

 

265,486

 

Depreciation and amortization

 

48,520

 

48,042

 

147,869

 

145,787

 

General and administrative

 

10,658

 

9,607

 

30,888

 

28,844

 

Acquisition related costs

 

1,559

 

1,539

 

2,972

 

2,287

 

Total expenses

 

154,459

 

147,069

 

453,393

 

442,404

 

Operating income

 

63,576

 

58,963

 

191,332

 

192,173

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

572

 

331

 

2,137

 

839

 

Interest expense (including amortization of debt discounts, premiums and deferred financing fees of $1,839, $1,574, $5,644 and $5,102, respectively)

 

(44,743

)

(41,786

)

(137,506

)

(129,912

)

Loss on asset impairment

 

 

 

(21,491

)

 

(Loss) gain on early extinguishment of debt

 

(1,044

)

 

(1,044

)

20,686

 

Equity in earnings of equity investments

 

1,999

 

2,957

 

6,643

 

3,818

 

Gain on issuance of shares by equity investee

 

18,390

 

 

34,808

 

 

Gain on sale of properties

 

22,832

 

 

34,336

 

 

Income from continuing operations before income tax expense

 

61,582

 

20,465

 

109,215

 

87,604

 

Income tax benefit (expense)

 

34

 

(176

)

(329

)

(518

)

Income from continuing operations

 

61,616

 

20,289

 

108,886

 

87,086

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

(Loss) income from discontinued operations

 

(374

)

1,804

 

(349

)

8,684

 

Gain on sale of properties

 

4,568

 

50,106

 

4,568

 

79,157

 

Net income

 

65,810

 

72,199

 

113,105

 

174,927

 

Preferred distributions

 

(12,667

)

(12,667

)

(38,001

)

(38,001

)

Net income available for common shareholders

 

$

53,143

 

$

59,532

 

$

75,104

 

$

136,926

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic

 

65,173

 

55,932

 

62,198

 

56,085

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — diluted

 

72,471

 

63,230

 

69,496

 

63,383

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations available for common shareholders

 

$

0.75

 

$

0.14

 

$

1.14

 

$

0.88

 

Income from discontinued operations

 

$

0.06

 

$

0.93

 

$

0.07

 

$

1.57

 

Net income available for common shareholders

 

$

0.82

 

$

1.06

 

$

1.21

 

$

2.44

 

 

See accompanying notes

 

2



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

113,105

 

$

174,927

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation

 

117,575

 

116,412

 

Amortization of debt discounts, premiums and deferred financing fees

 

5,644

 

5,102

 

Amortization of acquired real estate leases

 

23,420

 

26,584

 

Other amortization

 

12,216

 

11,241

 

Loss on asset impairment

 

21,491

 

 

Loss (gain) on early extinguishment of debt

 

1,044

 

(20,686

)

Equity in earnings of equity investments

 

(6,643

)

(3,818

)

Gain on issuance of shares by equity investee

 

(34,808

)

 

Distributions of earnings from equity investments

 

6,660

 

 

Gain on sale of properties

 

(38,904

)

(79,157

)

Change in assets and liabilities:

 

 

 

 

 

Decrease (increase) in restricted cash

 

5,808

 

(801

)

Increase in rents receivable and other assets

 

(36,581

)

(20,525

)

(Decrease) increase in accounts payable and accrued expenses

 

(10,951

)

169

 

Increase in rent collected in advance

 

2,049

 

2,031

 

(Decrease) increase in security deposits

 

(59

)

3,469

 

Increase in due to affiliates

 

17,293

 

18,644

 

Cash provided by operating activities

 

198,359

 

233,592

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Real estate acquisitions and improvements

 

(406,983

)

(470,564

)

Proceeds from investment in marketable pass through certificates

 

8,000

 

 

Investment in marketable pass through certificates

 

 

(6,760

)

Proceeds from sale of properties, net

 

230,911

 

212,057

 

Distributions in excess of earnings from equity investments

 

5,379

 

 

Investment in Affiliates Insurance Company

 

(75

)

(5,109

)

Increase in restricted cash

 

(1,221

)

 

Cash used in investing activities

 

(163,989

)

(270,376

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common shares, net

 

430,778

 

 

Repurchase and retirement of common shares

 

 

(14,486

)

Repurchase and retirement of outstanding debt securities

 

 

(88,251

)

Proceeds from borrowings

 

1,148,632

 

605,000

 

Payments on borrowings

 

(1,317,027

)

(321,728

)

Deferred financing fees

 

(9,565

)

(7,026

)

Distributions to common shareholders

 

(90,168

)

(81,015

)

Distributions to preferred shareholders

 

(38,001

)

(38,001

)

Purchase of noncontrolling equity interest

 

(2,500

)

 

Cash provided by financing activities

 

122,149

 

54,493

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

156,519

 

17,709

 

Cash and cash equivalents at beginning of period

 

18,204

 

15,518

 

Cash and cash equivalents at end of period

 

$

174,723

 

$

33,227

 

 

See accompanying notes

 

3



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(amounts in thousands)

(unaudited)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Supplemental cash flow information:

 

 

 

 

 

Interest paid

 

$

142,311

 

$

136,728

 

 

 

 

 

 

 

Non-cash investing activities:

 

 

 

 

 

Real estate acquisitions

 

$

 

$

(9

)

Investment in real estate mortgage receivable

 

 

(8,288

)

 

 

Net assets transferred to Government Properties Income Trust

 

 

395,317

 

 

 

 

 

 

 

Non-cash financing activities:

 

 

 

 

 

Issuance of common shares

 

$

896

 

$

628

 

Secured credit facility and related deferred financing fees transferred to Government Properties Income Trust

 

 

(243,199

)

 

See accompanying notes

 

4



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

 

Note 1.  Basis of Presentation

 

The accompanying condensed consolidated financial statements of CommonWealth REIT, or CWH, we or us, and its subsidiaries have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2009, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

 

Note 2.  New Accounting Pronouncements

 

In January 2010, the Financial Accounting Standards Board, or the FASB, issued an accounting standards update requiring additional disclosures regarding fair value measurements.  The update requires entities to disclose additional information regarding assets and liabilities that are transferred between levels within the fair value hierarchy.  The update also clarifies the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair values.  The update is effective for interim and annual reporting periods beginning after December 15, 2009 except for the requirement to separately disclose purchases, sales, issuances and settlements in the Level 3 roll forward that becomes effective for fiscal periods beginning after December 15, 2010.

 

The adoption of this update does not, and is not expected to, cause any material changes to the disclosures in our condensed consolidated financial statements.

 

Note 3.  Securities Held to Maturity

 

Until August 2, 2010, we held $8,000 of marketable commercial mortgage pass through certificates, or certificates, which were backed by our mortgage notes payable due January 2011 that were purchased in 2009 for $6,760. We classified these certificates as investments held to maturity rather than available for sale or trading because we had the intent and ability to hold these certificates until maturity.  We followed the amortized cost method of accounting for these certificates.  Under this method, we amortized the difference between the face value of the certificates and their purchase price to income using the interest method over the expected remaining term of the certificates.  As of December 31, 2009, these certificates had a carrying value of $7,267 and were included in other assets in our consolidated balance sheet.  As of December 31, 2009, these certificates had an estimated fair market value of $7,443.  On August 2, 2010, we prepaid the underlying mortgage notes payable, received $8,000 from our investment in these certificates and recorded a gain of $376 from the recognition of unamortized interest income.  This gain is included in interest and other income in our condensed consolidated statements of income.

 

Note 4.  Real Estate Properties

 

Since January 1, 2010, we acquired 32 properties for aggregate purchase prices of $552,625, excluding closing costs; we have also sold 16 properties for aggregate sales prices of $240,750, excluding closing costs.

 

5



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

In April 2010, we acquired an office property located in Denver, CO with 248,493 square feet.  The purchase price was $75,000, excluding closing costs.  We allocated $4,720 to land, $58,890 to buildings and improvements and $11,390 to acquired real estate leases.

 

In April 2010, we acquired an office property located in Colorado Springs, CO with 77,411 square feet.  The purchase price was $10,800, excluding closing costs.  We allocated $1,250 to land, $7,982 to buildings and improvements, $1,576 to acquired real estate leases and $8 to acquired real estate lease obligations.

 

In June 2010, we acquired two office properties located in Ann Arbor, MI with a combined 410,410 square feet.  The aggregate purchase price was $65,200, excluding closing costs.  We allocated $6,760 to land, $46,988 to buildings and improvements, $11,875 to acquired real estate leases and $423 to acquired real estate lease obligations.

 

In June 2010, we acquired two office properties located in Carson, CA with a combined 212,000 square feet.  The aggregate purchase price was $27,925, excluding closing costs.  We allocated $7,460 to land, $18,033 to buildings and improvements, $3,415 to acquired real estate leases and $983 to acquired real estate lease obligations.

 

In July 2010, we acquired two office properties located in Stafford, VA with a combined 117,949 square feet.  The aggregate purchase price was $18,750, excluding closing costs.  We allocated $1,929 to land, $15,656 to buildings and improvements, $1,182 to acquired real estate leases and $17 to acquired real estate lease obligations.

 

In August 2010, we acquired one office property located in Milwaukee, WI with 432,092 square feet.  The purchase price was $80,200, excluding closing costs.  We allocated $3,150 to land, $70,124 to buildings and improvements, $7,795 to acquired real estate leases and $869 to acquired real estate lease obligations.

 

In August 2010, we acquired seven properties located in Monterey, CA, consisting of approximately 1,155 acres of triple net leased agricultural land and related fixtures and improvements.  The aggregate purchase price was $28,000, excluding closing costs.  We allocated $9,657 to land and $18,343 to fixtures and improvements based on currently available information.  These preliminary allocations are subject to change pending an evaluation by an independent real estate appraisal firm that is expected to be finalized during the fourth quarter of 2010.

 

In September 2010, we acquired one office property located in Greensboro, NC with 323,773 square feet.  The purchase price was $44,650, excluding closing costs.  We allocated $2,070 to land, $37,073 to buildings and improvements, $5,663 to acquired real estate leases and $156 to acquired real estate lease obligations.

 

In October 2010, we acquired MacarthurCook Industrial Property Fund, an Australian property trust that owns 10 industrial properties with approximately 1,400,000 square feet.  The purchase price for these properties was approximately $83,200, excluding acquired positive working capital and closing costs.

 

In October 2010, we acquired three office properties located in Carson, CA with a combined 190,000 square feet.  The aggregate purchase price was $22,650, excluding closing costs.

 

In October 2010, we acquired a two tower office property located in Chicago, IL with 631,445 square feet.  The purchase price was $96,250, excluding closing costs.

 

In October 2010, we entered a purchase and sale agreement to acquire seven office properties located in Birmingham, AL with a combined 904,109 square feet.  We expect to acquire these properties during the fourth quarter of 2010; however, this acquisition is subject to customary closing conditions and no assurance can be given that this acquisition will be consummated in that time period or at all.

 

6



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

In June 2010, we entered agreements to sell 15 properties to our former subsidiary, Government Properties Income Trust, or GOV, that contain approximately 1,900,000 square feet for an aggregate sales price of $231,000, excluding closing costs.  All 15 of these properties have been sold as of September 30, 2010, and we recognized total gains of $34,336, exclusive of deferred gains of $14,588 attributable to our ownership interest in GOV.  In addition, the net book value for four of these properties exceeded their allocated sales prices, and we recorded impairment charges of $21,491 during the second quarter of 2010.

 

In September 2010, we sold an office property located in Irondequoit (Rochester), NY with approximately 310,000 square feet for $9,750, excluding closing costs.  In connection with this sale, we provided mortgage financing to the buyer, a not for profit hospital entity, totaling $8,288 at 4.75% per annum and recognized a gain on sale of $4,568 during the three months ended September 30, 2010.

 

During the nine months ended September 30, 2010, we funded $43,599 of improvements to our owned properties.

 

As of September 30, 2010 and December 31, 2009, we had one office property located in Los Angeles, CA with approximately 79,000 square feet classified as held for sale in our consolidated balance sheets.  This property was under contract for sale since June 2008; however, the purchase contract expired and we recognized the $750 nonrefundable deposit previously paid by the buyer in other income when the buyer was unable to meet its obligation to close on January 26, 2010.  We continue to actively market this property for sale.

 

We classify all properties actively marketed, under contract, in active negotiations or otherwise probable for sale within one year as held for sale in our consolidated balance sheets.  Results of operations for properties sold or held for sale are included in discontinued operations in our consolidated statements of income, except for properties sold to GOV.  Properties sold to GOV are not considered discontinued operations under GAAP because of our retained equity interest in this former subsidiary.  Summarized balance sheet information for all properties classified as held for sale and income statement information for properties sold or held for sale, except for properties sold to GOV, is as follows:

 

Balance Sheets:

 

 

 

September 30,
2010

 

December 31,
2009

 

Real estate property, net

 

$

8,195

 

$

8,192

 

Other assets, net

 

102

 

71

 

Properties held for sale

 

$

8,297

 

$

8,263

 

 

 

 

 

 

 

Rent collected in advance

 

$

11

 

$

14

 

Other liabilities related to properties held for sale

 

$

11

 

$

14

 

 

Income Statements:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Rental income

 

$

23

 

$

2,586

 

$

1,070

 

$

13,299

 

Operating expenses

 

(313

)

(562

)

(1,170

)

(3,735

)

Depreciation and amortization

 

(42

)

(123

)

(131

)

(372

)

General and administrative

 

(42

)

(97

)

(118

)

(508

)

(Loss) income from discontinued operations

 

$

(374

)

$

1,804

 

$

(349

)

$

8,684

 

 

7



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 5.  Equity Investments

 

At September 30, 2010 and December 31, 2009, we had the following equity investments in GOV and Affiliates Insurance Company, or AIC:

 

 

 

Ownership Percentage

 

Equity Investments

 

Equity in Earnings
(Loss)

 

Equity in Earnings
(Loss)

 

 

 

September 30,

 

December 31,

 

September 30,

 

December 31,

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

GOV

 

24.6

%

46.3

%

$

168,663

 

$

153,822

 

$

1,964

 

$

2,980

 

$

6,660

 

$

3,950

 

AIC

 

14.3

 

14.3

 

5,058

 

5,000

 

35

 

(23

)

(17

)

(132

)

 

 

 

 

 

 

$

173,721

 

$

158,822

 

$

1,999

 

$

2,957

 

$

6,643

 

$

3,818

 

 

At September 30, 2010, we owned 9,950,000, or approximately 24.6%, of the common shares of beneficial interest of GOV, with a carrying value of $168,663 and a market value, based on quoted market prices, of $265,665 ($26.70 per share).  GOV is a real estate investment trust, or REIT, which owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its initial public offering, or IPO, in June 2009 when it became a separate public entity.  In January 2010, GOV issued 9,775,000 common shares in a public offering for $21.50 per common share, raising net proceeds of approximately $199,300.  As a result of this transaction, our ownership percentage in GOV was reduced from 46.3% prior to this transaction to 31.8% after this transaction, and we recognized a gain of $16,418.  In August 2010, GOV issued an additional 9,200,000 common shares in a public offering for $25.00 per common share, raising net proceeds of approximately $219,900.  As a result of this transaction, our ownership percentage in GOV was reduced from 31.8% prior to this transaction to 24.6% after this transaction, and we recognized a gain of $18,390.

 

In connection with GOV’s IPO, we and GOV entered into a transaction agreement in which, among other things, we granted GOV the right of first refusal to acquire any property owned by us that we determine to divest, if the property is then majority leased to a government tenant, including the 15 properties we sold to GOV during 2010.  The sales for these 15 properties were negotiated by special committees of our and GOV’s boards of trustees composed solely of independent trustees who are not also trustees of the other party.

 

Since GOV’s IPO, our investment in it has been accounted for using the equity method.  Under the equity method, we record our percentage share of net earnings of GOV in our consolidated statements of income.  Prior to its IPO, the operating results and assets of GOV were included in our results of operations and balance sheet.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.

 

During the nine months ended September 30, 2010, we received cash distributions totaling $12,039 from GOV.

 

8



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following summarized financial data of GOV, as reported in its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2010 includes results of operations prior to June 8, 2009 (the date GOV became a separate public company) which are included in our consolidated results of operations when GOV was our wholly owned subsidiary.  References in our financial statements to the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2010 for GOV are included as textual references only, and the information in GOV’s Quarterly Report for the quarterly period ended September 30, 2010 is not incorporated by reference into our financial statements.

 

 

 

September 30,
2010

 

December 31,
2009

 

Real estate properties, net

 

$

793,380

 

$

463,730

 

Acquired real estate leases, net

 

55,129

 

15,310

 

Cash and cash equivalents

 

2,314

 

1,478

 

Restricted cash

 

860

 

 

Rents receivable, net

 

21,052

 

13,544

 

Other assets, net

 

25,846

 

20,751

 

Total assets

 

$

898,581

 

$

514,813

 

 

 

 

 

 

 

Mortgage notes payable

 

$

35,760

 

$

 

Revolving credit facility

 

63,000

 

144,375

 

Acquired real estate lease obligations, net

 

11,419

 

3,566

 

Other liabilities

 

20,934

 

14,822

 

Shareholders’ equity

 

767,468

 

352,050

 

Total liabilities and shareholders’ equity

 

$

898,581

 

$

514,813

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Rental income

 

$

30,746

 

$

19,656

 

$

80,040

 

$

58,304

 

Operating expenses

 

(11,275

)

(6,719

)

(27,537

)

(19,693

)

Depreciation and amortization

 

(6,321

)

(3,828

)

(16,602

)

(11,189

)

Acquisition related costs

 

(2,687

)

(207

)

(4,542

)

(207

)

General and administrative

 

(1,833

)

(1,216

)

(4,909

)

(2,829

)

Operating income

 

8,630

 

7,686

 

26,450

 

24,386

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

12

 

1

 

80

 

45

 

Interest expense

 

(1,973

)

(1,472

)

(5,182

)

(3,832

)

Equity in earnings (losses) of investee

 

35

 

 

(17

)

 

Income before income tax expense

 

6,704

 

6,215

 

21,331

 

20,599

 

Income tax expense

 

(35

)

(30

)

(77

)

(30

)

Net income

 

$

6,669

 

$

6,185

 

$

21,254

 

$

20,569

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

36,369

 

21,455

 

32,265

 

12,852

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

$

0.18

 

$

0.29

 

$

0.66

 

$

1.60

 

 

As of September 30, 2010, we have invested $5,208 in AIC, an insurance company organized by Reit Management & Research LLC, or RMR, and companies to which RMR provides management services.  All of our trustees serve on the board of directors of AIC.  At September 30, 2010, we owned approximately 14.3% of the common shares of AIC, with a carrying value of $5,058.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because each of our trustees is a director of AIC.  Under the equity method, we record our percentage share of net earnings from AIC in our consolidated statements of income.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.  In evaluating the fair value of this investment, we

 

9



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

have considered, among other things, the assets and liabilities held by AIC, AIC’s overall financial condition, and the financial condition and prospects for the insurance industry generally.

 

In June 2010, we, RMR and other companies to which RMR provides management services purchased property insurance pursuant to an insurance program arranged by AIC.  Our annual premiums for this property insurance are expected to be approximately $5,328.  We are currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance.

 

Note 6.  Real Estate Mortgage Receivable

 

We provided mortgage financing for $8,288 at 4.75% per annum in connection with an office property sold in September 2010.  This real estate mortgage requires monthly principal and interest payments and matures on September 30, 2020.  As of September 30, 2010, this mortgage had a carrying value of $8,288 and was included in other assets in our condensed consolidated balance sheet.

 

Note 7.  Indebtedness

 

In August 2010, we entered a new $750,000 unsecured revolving credit facility that we use for acquisitions, working capital and general business purposes.  The new facility replaces our previous $750,000 unsecured revolving credit facility, which had a maturity date of August 22, 2010.  The maturity date of the new facility is August 8, 2013 and includes an option for us to extend the facility for one year to August 8, 2014.  The new facility also includes a feature under which the maximum borrowing may be increased to up to $1,500,000 in certain circumstances.  Interest paid under the new facility is set at LIBOR plus 200 basis points, subject to adjustments based on our credit ratings.  The interest rate on our revolving credit facilities averaged 1.5% and 1.0% per annum for the nine months ended September 30, 2010 and 2009, respectively.  As of September 30, 2010, we had zero outstanding and $750,000 available under our new revolving credit facility.

 

In August 2010, we repaid at maturity all $30,000 of our 8.875% senior notes due in 2010.  We also prepaid at par $266,674 of mortgage debt that was scheduled to mature in 2011 and 2029.  In connection with the prepayment of this mortgage debt, we recorded a loss on early extinguishment of debt of $1,044 from the write off of unamortized discounts and deferred financing fees during the third quarter of 2010.  We funded these payments with borrowings under our revolving credit facility.

 

In September 2010, we issued $250,000 of unsecured senior notes in a public offering, raising net proceeds of approximately $242,483.  These notes bear interest at 5.875% per annum, require semi-annual interest payments and mature in September 2020.  Net proceeds from these notes were used to repay amounts then outstanding under our revolving credit facility.

 

Our public debt indentures and credit facility agreement contain a number of financial and other covenants, including a credit facility covenant which restricts our ability to make distributions under certain circumstances.  At September 30, 2010, we believe that we are in compliance with these financial and other covenants.

 

At September 30, 2010, 15 of our properties costing $598,225 with an aggregate net book value of $493,032 were secured by $352,575 of mortgage debt maturing between 2011 and 2027.

 

In October 2010, we repaid at maturity, all $20,000 of our 8.625% senior notes due in 2010 using cash on hand.

 

Note 8.  Shareholders’ Equity

 

During the nine months ended September 30, 2010, we issued 16,125,000 common shares in two public offerings, raising net proceeds of $430,778.

 

10



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Other comprehensive income includes unrealized gains or losses on the fair value of our interest rate swap agreements and other investments.  Our interest rate swap agreements qualify as cash flow hedges and convert the floating interest rate on a $175,000 mortgage note payable to a fixed interest rate.  The following is a reconciliation of net income to total comprehensive income for the three and nine months ended September 30, 2010 and 2009:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

Net income

 

$

65,810

 

$

72,199

 

$

113,105

 

$

174,927

 

Unrealized loss on derivative instrument

 

(5,150

)

 

(15,965

)

 

Unrealized loss on investment in available for sale securities

 

(141

)

 

(141

)

 

Total comprehensive income

 

$

60,519

 

$

72,199

 

$

96,999

 

$

174,927

 

 

On April 14, 2010, we issued 1,250 common shares, valued at $32.44 per share, the closing price of our common shares on the New York Stock Exchange, or NYSE, on that day, to each of our five trustees as part of their annual compensation.  On September 17, 2010, pursuant to our equity compensation plan, we granted an aggregate of 42,375 common shares of beneficial interest, par value $0.01 per share, valued at $27.30 per share, the closing price of our common shares on the NYSE, on that day, to our officers and certain employees of our manager, RMR.

 

On June 14, 2010, our board of trustees approved a reverse stock split that resulted in a one for four combination of our common shares of beneficial interest, $0.01 par value per share, effective July 1, 2010.  The reverse stock split reduced the number of our issued and outstanding common shares from 258,385,241 to 64,596,311.  The number of our authorized common shares did not change.  As required, common share amounts presented for all periods have been restated to reflect the reverse stock split.  As a result of the reverse stock split, the conversion rate of our 15,180,000 outstanding series D cumulative convertible preferred shares, or series D preferred shares, automatically changed from 1.9231 common shares per series D preferred share to 0.480775 common share per series D preferred share (the equivalent of a change in conversion price from $13.00 per common share to $52.00 per common share).

 

11



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 9.  Fair Value of Assets and Liabilities

 

The table below presents certain of our assets and liabilities measured at fair value at September 30, 2010, categorized by the level of inputs used in the valuation of each asset and liability:

 

 

 

 

 

Fair Value at Reporting Date Using

 

Description

 

Total

 

Quoted Prices in Active
Markets for Identical
Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Properties held for sale (1)

 

$

8,195

 

$

 

$

8,195

 

$

 

Effective portion of interest rate contracts (2)

 

$

(13,418

)

$

 

$

(13,418

)

$

 

Investment in available for sale securities (3)

 

$

407

 

$

407

 

$

 

$

 

 


(1)   Properties held for sale are reported at the lower of carrying value or fair value less costs to sell and consists of one property that we expect to sell within one year.  We used our estimate of fair value less estimated closing costs to determine the fair value of this property (level 2 inputs).

 

(2)   The fair value of our interest rate swap contracts is determined using the net discounted cash flows of the expected cash flows of each derivative based on the market based interest rate curve (level 2 inputs) and adjusted for our credit spread and the actual and estimated credit spreads of the counterparties (level 3 inputs).  Although we have determined that the majority of the inputs used to value our derivatives fall within level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and the counterparties.  As of September 30, 2010, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives.  As a result, we have determined that our derivative valuations in their entirety are classified as level 2 inputs in the fair value hierarchy.

 

(3)   The fair value of our investment in available for sale securities is based on quoted prices at September 30, 2010 in active markets (level 1 inputs) and is included in other assets in our condensed consolidated balance sheet.

 

We are exposed to certain risks relating to our ongoing business operations.  The primary risk managed by using our derivative instruments is interest rate risk.  We enter into interest rate swaps to manage interest rate risk associated with our floating rate borrowings.  We have interest rate swap agreements to manage our interest rate risk exposure on $175,000 of mortgage notes due 2019, which require interest at a spread over LIBOR.  The interest rate swap agreements utilized by us qualify as cash flow hedges and effectively modify our exposure to interest rate risk by converting our floating interest rate debt to a fixed interest rate basis for this loan through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  These agreements involve the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the life of the agreements without an exchange of the underlying principal amount.  The fair value of our derivative instruments decreased by $5,150 and $15,965 during the three and nine months ended September 30, 2010, respectively, based primarily on changes in market interest rates.  As of September 30, 2010, the fair value of these derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive income (loss) in our consolidated balance sheet totaled ($13,418).  As of December 31, 2009, the fair value of these derivative instruments included in other assets and cumulative other comprehensive income (loss) in our consolidated balance sheet totaled $2,547.

 

12



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

In addition to the assets and liabilities described in the above table, our financial instruments include our cash and cash equivalents, rents receivable, equity investments, real estate mortgage receivable, marketable pass through certificates, restricted cash, revolving credit facility, senior notes and mortgage notes payable, accounts payable and other accrued expenses, rent collected in advance, security deposits and amounts due to affiliates.  At September 30, 2010 and December 31, 2009, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Equity investment in GOV

 

$

168,663

 

$

265,665

 

$

153,822

 

$

228,651

 

Marketable pass through certificates

 

$

 

$

 

$

7,267

 

$

7,443

 

Senior notes and mortgage notes payable

 

$

2,483,472

 

$

2,640,614

 

$

2,539,431

 

$

2,547,036

 

 

At September 30, 2010 and December 31, 2009, the fair values of our equity investment in GOV are based on quoted market prices of $26.70 and $22.98, respectively.  At December 31, 2009, the fair values of our marketable pass through certificates are based on quoted market prices of $93.04.  The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads.

 

Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, none of our tenants are responsible for more than 2% of our total rents.

 

Note 10.  Earnings Per Common Share

 

The effect of our convertible preferred shares on income from continuing operations available for common shareholders per share is anti-dilutive for the periods presented.

 

Note 11.  Segment Information

 

As of September 30, 2010, we owned 285 suburban office properties, 41 central business district, or CBD, office properties and 193 industrial & other properties, excluding one property classified as held for sale and included in discontinued operations.  We account for all of these properties in geographic operating segments for financial reporting purposes based on our method of internal reporting.  We account for our properties by property type (i.e. suburban office, CBD office and industrial & other) and by geographic regions.  We define these individual geographic segments as those which currently, or during either of the last two quarters, represent or generate 5% or more of our total square feet, revenues or property net operating income, or NOI, which we define as rental income less property level operating expenses.  Prior periods have been restated to reflect one office property reclassified from discontinued operations during the fourth quarter of 2009 and one office property reclassified from continuing operations during the third quarter of 2010.  Property level information as of and for the three and nine months ended September 30, 2010 and 2009, excluding discontinued operations, is as follows:

 

 

 

As of September 30, 2010

 

As of September 30, 2009

 

 

 

Suburban
Office

 

CBD
Office

 

Industrial &
Other

 

Totals

 

Suburban
Office

 

CBD
Office

 

Industrial
& Other

 

Totals

 

Property square feet (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

700

 

4,592

 

 

5,292

 

701

 

4,584

 

 

5,285

 

Oahu, HI

 

 

 

17,914

 

17,914

 

 

 

17,914

 

17,914

 

Metro Denver, CO

 

788

 

672

 

553

 

2,013

 

539

 

670

 

548

 

1,757

 

Metro Washington, DC

 

1,067

 

428

 

 

1,495

 

1,287

 

582

 

 

1,869

 

Metro Boston, MA

 

2,003

 

390

 

 

2,393

 

2,101

 

523

 

 

2,624

 

Other markets

 

17,603

 

6,755

 

13,041

 

37,399

 

16,869

 

6,756

 

12,696

 

36,321

 

Totals

 

22,161

 

12,837

 

31,508

 

66,506

 

21,497

 

13,115

 

31,158

 

65,770

 

 

13



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

Three Months Ended September 30, 2010

 

Three Months Ended September 30, 2009

 

 

 

Suburban
Office

 

CBD
Office

 

Industrial &
Other

 

Totals

 

Suburban
Office

 

CBD
Office

 

Industrial
& Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

2,828

 

$

27,920

 

$

 

$

30,748

 

$

2,733

 

$

28,753

 

$

 

$

31,486

 

Oahu, HI

 

 

 

18,114

 

18,114

 

 

 

18,872

 

18,872

 

Metro Denver, CO

 

3,778

 

5,238

 

2,124

 

11,140

 

1,333

 

5,271

 

1,948

 

8,552

 

Metro Washington, DC

 

7,471

 

4,284

 

 

11,755

 

7,505

 

3,801

 

 

11,306

 

Metro Boston, MA

 

7,087

 

4,797

 

 

11,884

 

7,313

 

5,401

 

 

12,714

 

Other markets

 

74,032

 

41,081

 

19,281

 

134,394

 

67,920

 

37,855

 

17,327

 

123,102

 

Totals

 

$

95,196

 

$

83,320

 

$

39,519

 

$

218,035

 

$

86,804

 

$

81,081

 

$

38,147

 

$

206,032

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

1,191

 

$

14,112

 

$

 

$

15,303

 

$

1,123

 

$

15,336

 

$

 

$

16,459

 

Oahu, HI

 

 

 

13,542

 

13,542

 

 

 

13,729

 

13,729

 

Metro Denver, CO

 

2,773

 

3,409

 

1,201

 

7,383

 

638

 

3,544

 

1,141

 

5,323

 

Metro Washington, DC

 

4,372

 

2,747

 

 

7,119

 

4,711

 

2,231

 

 

6,942

 

Metro Boston, MA

 

4,384

 

1,691

 

 

6,075

 

4,404

 

2,496

 

 

6,900

 

Other markets

 

40,331

 

21,089

 

13,471

 

74,891

 

37,559

 

19,765

 

11,474

 

68,798

 

Totals

 

$

53,051

 

$

43,048

 

$

28,214

 

$

124,313

 

$

48,435

 

$

43,372

 

$

26,344

 

$

118,151

 

 

 

 

Nine Months Ended September 30, 2010

 

Nine Months Ended September 30, 2009

 

 

 

Suburban
Office

 

CBD
Office

 

Industrial &
Other

 

Totals

 

Suburban
Office

 

CBD
Office

 

Industrial
& Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

8,336

 

$

84,165

 

$

 

$

92,501

 

$

8,045

 

$

84,660

 

$

 

$

92,705

 

Oahu, HI

 

 

 

54,457

 

54,457

 

 

 

54,622

 

54,622

 

Metro Denver, CO

 

8,999

 

15,715

 

6,233

 

30,947

 

7,026

 

5,594

 

5,932

 

18,552

 

Metro Washington, DC

 

22,371

 

14,655

 

 

37,026

 

27,866

 

18,077

 

 

45,943

 

Metro Boston, MA

 

21,425

 

14,943

 

 

36,368

 

22,148

 

16,407

 

 

38,555

 

Other markets

 

214,954

 

121,607

 

56,865

 

393,426

 

221,757

 

110,442

 

52,001

 

384,200

 

Totals

 

$

276,085

 

$

251,085

 

$

117,555

 

$

644,725

 

$

286,842

 

$

235,180

 

$

112,555

 

$

634,577

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

3,359

 

$

43,066

 

$

 

$

46,425

 

$

3,384

 

$

44,379

 

$

 

$

47,763

 

Oahu, HI

 

 

 

40,569

 

40,569

 

 

 

41,598

 

41,598

 

Metro Denver, CO

 

6,399

 

10,526

 

3,592

 

20,517

 

4,206

 

3,733

 

3,505

 

11,444

 

Metro Washington, DC

 

13,028

 

9,803

 

 

22,831

 

17,645

 

10,883

 

 

28,528

 

Metro Boston, MA

 

13,268

 

6,872

 

 

20,140

 

13,210

 

8,111

 

 

21,321

 

Other markets

 

119,437

 

63,300

 

39,842

 

222,579

 

125,885

 

58,055

 

34,497

 

218,437

 

Totals

 

$

155,491

 

$

133,567

 

$

84,003

 

$

373,061

 

$

164,330

 

$

125,161

 

$

79,600

 

$

369,091

 

 

14



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following table reconciles our calculation of NOI to net income, the most directly comparable financial measure under GAAP reported in our consolidated financial statements.  We consider NOI to be appropriate supplemental information to net income because it helps both investors and management to understand the operations of our properties.  We use NOI internally as a performance measure and believe NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are incurred at the property level.  Our management also uses NOI to evaluate individual, regional and company wide property level performance.  NOI excludes certain components from net income in order to provide results that are more closely related to our properties’ results of operations.  NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for common shareholders or cash flow from operating activities as a measure of financial performance.  A reconciliation of NOI to net income for the three and nine months ended September 30, 2010 and 2009, is as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Rental income

 

$

218,035

 

$

206,032

 

$

644,725

 

$

634,577

 

Operating expenses

 

(93,722

)

(87,881

)

(271,664

)

(265,486

)

Property net operating income (NOI)

 

$

124,313

 

$

118,151

 

$

373,061

 

$

369,091

 

 

 

 

 

 

 

 

 

 

 

Property NOI

 

$

124,313

 

$

118,151

 

$

373,061

 

$

369,091

 

Depreciation and amortization

 

(48,520

)

(48,042

)

(147,869

)

(145,787

)

General and administrative

 

(10,658

)

(9,607

)

(30,888

)

(28,844

)

Acquisition related costs

 

(1,559

)

(1,539

)

(2,972

)

(2,287

)

Operating income

 

63,576

 

58,963

 

191,332

 

192,173

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

572

 

331

 

2,137

 

839

 

Interest expense

 

(44,743

)

(41,786

)

(137,506

)

(129,912

)

Loss on asset impairment

 

 

 

(21,491

)

 

(Loss) gain on early extinguishment of debt

 

(1,044

)

 

(1,044

)

20,686

 

Equity in earnings of equity investments

 

1,999

 

2,957

 

6,643

 

3,818

 

Gain on issuance of shares by equity investee

 

18,390

 

 

34,808

 

 

Gain on sale of properties

 

22,832

 

 

34,336

 

 

Income from continuing operations before income tax expense

 

61,582

 

20,465

 

109,215

 

87,604

 

Income tax benefit (expense)

 

34

 

(176

)

(329

)

(518

)

Income from continuing operations

 

61,616

 

20,289

 

108,886

 

87,086

 

(Loss) income from discontinued operations

 

(374

)

1,804

 

(349

)

8,684

 

Gain on sale of properties from discontinued operations

 

4,568

 

50,106

 

4,568

 

79,157

 

Net income

 

$

65,810

 

$

72,199

 

$

113,105

 

$

174,927

 

 

15



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 12.  Related Person Transactions

 

As discussed in Note 5, we own 9,950,000, or approximately 24.6%, of the common shares of beneficial interest of GOV, with a carrying value of $168,663 and a market value, based on quoted market prices, of $265,665 ($26.70 per share) as of September 30, 2010.  GOV is a REIT which owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its IPO in June 2009 when it became a separate publicly owned entity.  We and GOV are both managed by RMR and both our Managing Trustees are also Managing Trustees of GOV.

 

In June 2010, we entered agreements to sell 15 properties to GOV that contain approximately 1,900,000 square feet.  We sold all 15 of these properties for an aggregate sales price of $231,000, excluding closing costs.  In connection with GOV’s IPO, we and GOV entered into a transaction agreement in which, among other things, we granted GOV the right of first refusal to acquire any property owned by us that we determine to divest, if the property is then majority leased to a government tenant, including these 15 properties.  These transactions were negotiated by special committees of our and GOV’s boards of trustees composed solely of Independent Trustees who are not also trustees of the other party.

 

In connection with our business management agreement with RMR, we recognized expenses of $8,881 and $8,322 for the three months ended September 30, 2010 and 2009, respectively, and $26,053 and $25,266 for the nine months ended September 30, 2010 and 2009, respectively.  These amounts are included in general and administrative expenses and income (loss) from discontinued operations in our condensed consolidated financial statements.  In connection with our property management agreement with RMR, we recognized property and construction management fees of $6,592 and $6,321 for the three months ended September 30, 2010 and 2009, respectively, and $19,878 and $22,129 for the nine months ended September 30, 2010 and 2009, respectively.  The property and construction management fees are included in operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

 

As of September 30, 2010, we have invested $5,208 in AIC with RMR and other companies to which RMR provides management services.  All of our trustees serve on the board of directors of AIC.  At September 30, 2010, we owned approximately 14.3% of AIC.  Also, RMR provides certain management services to AIC.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because each of our trustees is a director of AIC.  This investment is carried on our condensed consolidated balance sheets in equity investments and had a carrying value of $5,058 and $5,000 as of September 30, 2010 and December 31, 2009, respectively.  During the three and nine months ended September 30, 2010, we invested an additional $31 and $75, respectively, in AIC.  During the three and nine months ended September 30, 2010, we recognized earnings and (losses) of $35 and ($17), respectively, related to this investment.  In June 2010, we, RMR and other companies to which RMR provides management services purchased property insurance pursuant to an insurance program arranged by AIC.  Our annual premiums for this property insurance are expected to be approximately $5,328.  We are currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance.

 

For more information about our related person transactions, including our dealings with GOV, RMR, AIC and our Managing Trustees and their affiliates, and about the risks which may arise as a result of these and other related person transactions, please see our Annual Report and our other filings made with the Securities and Exchange Commission, or the SEC, and in particular the sections captioned “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Related Person Transactions” in our Annual Report and the section captioned “Related Person Transactions and Company Review of Such Transactions” in our Proxy Statement dated February 23, 2010 relating to our 2010 Annual Meeting of Shareholders and Item 1.01 in our Current Report on Form 8-K dated January 27, 2010 and our Current Report on Form 8-K filed with the SEC on June 18, 2010.

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 13.  Subsequent Events

 

In October 2010, we redeemed the remaining 7,000,000 shares of our 8 ¾% series B preferred shares for $25.00 per share plus accrued and unpaid distributions, using borrowings under our revolving credit facility.

 

In October 2010, we declared a distribution of $0.50 per common share, or approximately $36,100, to be paid on or about November 22, 2010 to shareholders of record on October 22, 2010.  Prior to the July 1, 2010 one for four reverse stock split, regular quarterly distributions were $0.12 per share per quarter ($0.48 per share per year).  We also have announced a distribution on our series C preferred shares of $0.4453 per share, or $2,672, and a distribution on our series D preferred shares of $0.4063 per share, or $6,167, which we expect to pay on or about November 15, 2010 to our preferred shareholders of record as of November 1, 2010.  Other subsequent events have been disclosed within other notes to this Quarterly Report on Form 10-Q.

 

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Table of Contents

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and our Annual Report.

 

OVERVIEW

 

We primarily own office and industrial buildings in suburban and CBD locations throughout the United States.  We also own 17.9 million square feet of leased industrial and commercial lands located in Oahu, Hawaii.

 

Property Operations

 

As of September 30, 2010, 86.4% of our total square feet was leased, compared to 88.2% leased as of September 30, 2009.  These results reflect a 2.6 percentage point decrease in occupancy at properties we owned continuously since January 1, 2009.  Occupancy data for 2010 and 2009 is as follows (square feet in thousands):

 

 

 

All Properties (1)

 

Comparable Properties (2)

 

 

 

 

 

For the Nine Months

 

 

 

As of September 30,

 

Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Total properties

 

519

 

515

 

491

 

491

 

Total square feet

 

66,506

 

65,770

 

61,455

 

61,455

 

Percent leased (3)

 

86.4

%

88.2

%

85.6

%

88.2

%

 


(1)

Excludes properties classified in discontinued operations as of September 30, 2010.

(2)

Based on properties owned continuously since January 1, 2009, and excludes properties sold or classified in discontinued operations as of September 30, 2010.

(3)

Percent leased includes (i) space being fitted out for occupancy pursuant to signed leases and (ii) space which is leased but is not occupied or is being offered for sublease by tenants.

 

During the three months ended September 30, 2010, we signed lease renewals for 1,287,000 square feet and new leases for 733,000 square feet that had weighted average rental rates that were 3% above rents previously charged for the same space.  Average lease terms for leases signed during the three months ended September 30, 2010 were 5.8 years.  Commitments for tenant improvement and leasing costs for leases signed during the three months ended September 30, 2010 totaled $26.3 million, or $13.04 per square foot on average (approximately $2.25/sq. ft. per year of the lease term).

 

During the past twelve months, leasing market conditions in the majority of our markets have stabilized, but remain weak.  As a result, the amount of leasing activity within our portfolio has slowed and our occupancy has declined.  Required landlord funded tenant build outs and leasing commissions payable to tenant brokers for new leases and lease renewals have increased in certain markets since the second half of 2008.  These build out costs and leasing commissions are generally amortized as a reduction of our income during the terms of the affected leases.  We believe that the current high unemployment rate and weak leasing market conditions in the U.S. may lead to a continued decrease in occupancy and effective rents at our properties through the end of 2010, but we expect our occupancy may begin to improve in 2011.  However, there are too many variables for us to reasonably project what the financial impact of changing market conditions will be on our occupancy or financial results for future periods.

 

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Table of Contents

 

Approximately 15.4% of our leased square feet and 15.1% of our rents are included in leases scheduled to expire through December 31, 2011.  Lease renewals and rental rates at which available space may be relet in the future will depend on prevailing market conditions at the times these renewals and rates are negotiated.  Lease expirations by year, as of September 30, 2010, are as follows (square feet and dollars in thousands):

 

 

 

Square
Feet

 

% of
Square Feet

 

Cumulative
% of Square
Feet

 

Annualized
Rental
Income

 

% of
Annualized
Rental
Income

 

Cumulative
% of
Annualized
Rental
Income

 

Year

 

Expiring (1)

 

Expiring

 

Expiring

 

Expiring (2)

 

Expiring

 

Expiring

 

2010

 

3,623

 

6.3

%

6.3

%

$

47,072

 

5.4

%

5.4

%

2011

 

5,259

 

9.1

%

15.4

%

84,719

 

9.7

%

15.1

%

2012

 

5,464

 

9.5

%

24.9

%

103,295

 

11.9

%

27.0

%

2013

 

5,696

 

9.9

%

34.8

%

100,713

 

11.5

%

38.5

%

2014

 

4,490

 

7.8

%

42.6

%

77,599

 

8.9

%

47.4

%

2015

 

3,657

 

6.4

%

49.0

%

77,927

 

9.0

%

56.4

%

2016

 

3,329

 

5.8

%

54.8

%

56,147

 

6.5

%

62.9

%

2017

 

2,923

 

5.1

%

59.9

%

77,712

 

8.9

%

71.8

%

2018

 

2,256

 

4.0

%

63.9

%

52,366

 

6.0

%

77.8

%

2019

 

3,467

 

6.0

%

69.9

%

42,571

 

4.9

%

82.7

%

Thereafter

 

17,316

 

30.1

%

100.0

%

150,212

 

17.3

%

100.0

%

 

 

57,480

 

100.0

%

 

 

$

870,333

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average remaining lease term (in years):

 

7.8

 

 

 

 

 

5.8

 

 

 

 

 

 


(1)

Square feet is pursuant to signed leases as of September 30, 2010 and includes (i) space being fitted out for occupancy and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants. Excludes properties classified in discontinued operations.

(2)

Rents are pursuant to signed leases as of September 30, 2010, plus estimated expense reimbursements; includes some triple net lease rents and excludes lease value amortization. Excludes properties classified in discontinued operations.

 

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Table of Contents

 

Our principal source of funds for our operations is rents from tenants at our properties.  Rents are generally received from our tenants monthly in advance, except from our government tenants, who pay rents monthly in arrears.  As of September 30, 2010, tenants responsible for 1% or more of our total rent were as follows (square feet in thousands):

 

Tenant

 

Square
Feet (1)

 

% of Total
Square Feet (1)

 

% of
Rent (2)

 

Expiration

 

1.

Expedia, Inc.

 

349

 

0.6

%

2.0

%

2018

 

2.

PNC Financial Services Group

 

613

 

1.1

%

1.8

%

2011 to 2021

 

3.

John Wiley & Sons, Inc.

 

342

 

0.6

%

1.8

%

2017

 

4.

GlaxoSmithKline plc

 

608

 

1.1

%

1.7

%

2013

 

5.

U. S. Government (3)

 

470

 

0.8

%

1.6

%

2010 to 2021

 

6.

Wells Fargo Bank

 

477

 

0.8

%

1.4

%

2010 to 2017

 

7.

Jones Day (law firm)

 

407

 

0.7

%

1.2

%

2012, 2019

 

8.

The Bank of New York Mellon Corp.

 

390

 

0.7

%

1.1

%

2011, 2012,
2015, 2020

 

9.

Ballard Spahr Andrews & Ingersoll (law firm)

 

269

 

0.5

%

1.1

%

2011, 2012,
2015

 

10.

Flextronics International Ltd.

 

894

 

1.6

%

1.1

%

2014

 

11.

JDA Software Group, Inc.

 

283

 

0.5

%

1.1

%

2012

 

12.

ING

 

410

 

0.7

%

1.1

%

2011, 2018

 

13 

Towers Watson

 

334

 

0.6

%

1.0

%

2010 to 2020

 

 

Total

 

5,846

 

10.3

%

18.0

%

 

 

 


(1)

Square feet is pursuant to signed leases as of September 30, 2010 and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease by tenants. Excludes properties classified in discontinued operations.

(2)

Rent is pursuant to signed leases as of September 30, 2010, plus estimated expense reimbursements. Includes some triple net lease rents and excludes lease value amortization. Excludes properties classified in discontinued operations.

(3)

Including our 24.6% pro rata ownership of GOV as of September 30, 2010, the U.S. Government represents 1,723 square feet, or 2.9% of total square feet, and 4.7% of total rental income.

 

Investment Activities

 

Since January 1, 2010, we acquired 32 office and industrial properties with 4.1 million square feet for $552.6 million, excluding closing costs.  At the time of acquisition, these properties were 91.6% leased at rents which yielded approximately 9.7% of the aggregate gross purchase price, based on estimated annual NOI on the date of closing.

 

In January 2010, GOV issued 9,775,000 common shares in a public offering for $21.50 per common share, raising net proceeds of approximately $199.3 million.  In August 2010, GOV issued an additional 9,200,000 common shares in a public offering for $25.00 per common share, raising net proceeds of approximately $219.9 million.  As a result of these transactions, our ownership percentage in GOV was reduced from 46.3% prior to these transactions to 24.6% after these transactions, and we recognized gains totaling $34.8 million.

 

In June 2010, we entered agreements to sell 15 properties to GOV that contain approximately 1.9 million square feet for an aggregate sales price of $231.0 million, excluding closing costs.  All 15 of these properties have been sold as of September 30, 2010, and we recognized total gains of $34.3 million, exclusive of deferred gains of $14.6 million attributable to our ownership interest in GOV.  The net book value for four of these properties exceeded their allocated sales prices, and we recorded impairment charges of $21.5 million during the second quarter of 2010.

 

In September 2010, we sold an office property located in Irondequoit (Rochester), NY with approximately 310,000 square feet for $9.8 million, excluding closing costs.  In connection with this sale, we provided mortgage financing to the buyer, a not for profit hospital entity, totaling $8.3 million at 4.75% per annum and recognized a gain on sale of $4.6 million during the three months ended September 30, 2010.

 

20



Table of Contents

 

Financing Activities

 

In March and September 2010, we issued 8,625,000 and 7,500,000 common shares, respectively, in public offerings, raising net proceeds aggregating $430.8 million.  We used the net proceeds from these offerings to repay amounts then outstanding under our revolving credit facility and for general business purposes, including property acquisitions and debt repayments.

 

In August 2010, we entered a new $750.0 million unsecured revolving credit facility that we use for acquisitions, working capital and general business purposes.  The new facility replaces our previous $750.0 million unsecured revolving credit facility which had a maturity date of August 22, 2010.  The maturity date of the new facility is August 8, 2013, and includes an option for us to extend the facility for one year to August 8, 2014.  The new facility also includes a feature under which the maximum borrowing may be increased to up to $1.5 billion in certain circumstances.  Interest paid under the new facility is set at LIBOR plus 200 basis points, subject to adjustments based on our credit ratings.

 

In August 2010, we repaid at maturity all $30.0 million of our 8.875% senior notes due 2010.  We also prepaid at par $266.7 million of mortgage debt that was scheduled to mature in 2011 and 2029.  We funded these payments with borrowings under our revolving credit facility.

 

In September 2010, we issued $250.0 million of unsecured senior notes in a public offering, raising net proceeds of approximately $242.5 million.  These notes bear interest at 5.875% per annum, require semi-annual interest payments and mature in September 2020.  Net proceeds from these notes were used to repay amounts then outstanding under our revolving credit facility.

 

In October 2010, we repaid at maturity all $20.0 million of our 8.625% senior notes due in 2010 using cash on hand.

 

In October 2010, we redeemed the remaining 7,000,000 shares of our 83/4% series B preferred shares for $25.00 per share plus accrued and unpaid distributions, using borrowings under our revolving credit facility.

 

21



Table of Contents

 

RESULTS OF OPERATIONS

 

Three Months Ended September 30, 2010, Compared to Three Months Ended September 30, 2009

 

 

 

Three Months Ended September 30,

 

 

 

2010

 

2009

 

$
Change

 

%
Change

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

218,035

 

$

206,032

 

$

12,003

 

5.8

%

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

93,722

 

87,881

 

5,841

 

6.6

%

Depreciation and amortization

 

48,520

 

48,042

 

478

 

1.0

%

General and administrative

 

10,658

 

9,607

 

1,051

 

10.9

%

Acquisition related costs

 

1,559

 

1,539

 

20

 

1.3

%

Total expenses

 

154,459

 

147,069

 

7,390

 

5.0

%

 

 

 

 

 

 

 

 

 

 

Operating income

 

63,576

 

58,963

 

4,613

 

7.8

%

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

572

 

331

 

241

 

72.8

%

Interest expense

 

(44,743

)

(41,786

)

2,957

 

7.1

%

Loss on early extinguishment of debt

 

(1,044

)

 

1,044

 

100.0

%

Equity in earnings of equity investments

 

1,999

 

2,957

 

(958

)

(32.4

)%

Gain on issuance of shares by equity investee

 

18,390

 

 

18,390

 

100.0

%

Gain on sale of properties

 

22,832

 

 

22,832

 

100.0

%

Income from continuing operations before income tax expense

 

61,582

 

20,465

 

41,117

 

200.9

%

Income tax benefit (expense)

 

34

 

(176

)

210

 

(119.3

)%

Income from continuing operations

 

61,616

 

20,289

 

41,327

 

203.7

%

Discontinued operations:

 

 

 

 

 

 

 

 

 

(Loss) income from discontinued operations

 

(374

)

1,804

 

(2,178

)

(120.7

)%

Gain on sale of properties

 

4,568

 

50,106

 

(45,538

)

(90.9

)%

Net income

 

65,810

 

72,199

 

(6,389

)

(8.8

)%

Preferred distributions

 

(12,667

)

(12,667

)

 

%

Net income available for common shareholders

 

$

53,143

 

$

59,532

 

$

(6,389

)

(10.7

)%

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic

 

65,173

 

55,932

 

9,241

 

16.5

%

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — diluted

 

72,471

 

63,230

 

9,241

 

14.6

%

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations available for common shareholders

 

$

0.75

 

$

0.14

 

$

0.61

 

435.7

%

Income from discontinued operations

 

$

0.06

 

$

0.93

 

$

(0.87

)

(93.5

)%

Net income available for common shareholders

 

$

0.82

 

$

1.06

 

$

(0.24

)

(22.6

)%

 

22



Table of Contents

 

Rental income.  Rental income increased for the three months ended September 30, 2010, compared to the same period in 2009, primarily due to an increase in rental income from our Metro Denver, CO and Other Markets segments, as described in the segment information note to our condensed consolidated financial statements.  The aggregate increase primarily reflects the acquisition of 22 properties since July 1, 2009, offset by a decrease in rental income from the sale of 15 properties to GOV in 2010 and the decline in occupancy in 2010.  Rental income from our Metro Denver, CO segment increased by $2.6 million, or 30.3%, primarily reflecting one large property acquired in 2010.  Rental income from our Other Markets segment increased $11.3 million, or 9.2%, primarily reflecting the acquisition of 17 properties since July 1, 2009, offset by a decrease in rental income from the sale of 11 properties to GOV in 2010 and the decline in occupancy in 2010.  Rental income includes non-cash straight line rent adjustments totaling $3.5 million in 2010 and $5.5 million in 2009 and amortization of acquired real estate leases and obligations totaling ($1.9) million in 2010 and ($3.3) million in 2009.  Rental income also includes lease termination fees totaling $554,000 in 2010 and $559,000 in 2009.

 

Total expenses.  The increase in total expenses primarily reflects the acquisition of properties since July 1, 2009, offset by the sale of 15 properties to GOV in 2010.  The increase in general and administrative expenses is also attributable to an increase in legal fees associated with our industrial and commercial land in Hawaii.

 

Interest expense.  The increase in interest expense in 2010 primarily reflects the issuance during the fourth quarter of 2009 of $125.0 million of 7.50% unsecured senior notes and $175.0 million of mortgage debt with a current interest rate of 5.66% and the issuance of $250.0 million of 5.875% unsecured senior notes during 2010, offset by the prepayment of $266.7 million of mortgage debt and the repayment of $30.0 million of senior notes in August 2010.

 

Loss on early extinguishment of debt.  The loss on early extinguishment of debt in 2010 reflects the write off of unamortized discounts and deferred financing fees associated with the prepayment of $266.7 million of mortgage debt in August 2010.

 

Equity in earnings of equity investments.  Equity in earnings of equity investments represents our proportionate share of earnings from AIC and from GOV.

 

Gain on issuance of shares by equity investee.  The gain on issuance of shares by equity investee reflects the issuance of 9,200,000 common shares by GOV in August 2010 at prices above our per share carrying value.

 

Gain on sale of properties from continuing operations.  Proceeds from the sale of 12 office properties to GOV during the third quarter of 2010 were $189.0 million. We recognized gains on the sale of these properties totaling $22.8 million, exclusive of deferred gains of $9.2 million attributable to our ownership interest in GOV.

 

Income from continuing operations.  The increase in income from continuing operations is due primarily to the gain on issuance of shares by GOV in 2010, gains on sale of properties in 2010, and income from acquisitions made during 2009 and 2010, offset by an increase in interest expense, the decline in occupancy in 2010 and the sale of 15 properties to GOV in 2010.

 

(Loss) income from discontinued operations.  (Loss) income from discontinued operations reflects operating results from ten office properties sold during 2009, one office property sold in 2010 and one office property classified as held for sale as of September 30, 2010.

 

Gain on sale of properties from discontinued operations.  Net sales proceeds and gain from the sale of one office property in 2010 were $1.5 million and $4.6 million, respectively.  Net sales proceeds and gains from the sale of seven office properties in 2009 were $142.3 million and $50.1 million, respectively.

 

Net income and net income available for common shareholders.  The decrease in net income and net income available for common shareholders is due primarily to the gains on the sale of properties recognized in 2009 compared to 2010, a decrease in rents from properties sold in 2009 and 2010, an increase in interest expense, and the decline in occupancy in 2010, offset by the gain recognized on the issuance of common shares by GOV in 2010 and income from acquisitions made during 2009 and 2010.  Net income available for common shareholders is net income reduced by preferred distributions.

 

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Table of Contents

 

Nine Months Ended September 30, 2010, Compared to Nine Months Ended September 30, 2009

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

$
Change

 

%
Change

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

644,725

 

$

634,577

 

$

10,148

 

1.6

%

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

271,664

 

265,486

 

6,178

 

2.3

%

Depreciation and amortization

 

147,869

 

145,787

 

2,082

 

1.4

%

General and administrative

 

30,888

 

28,844

 

2,044

 

7.1

%

Acquisition related costs

 

2,972

 

2,287

 

685

 

30.0

%

Total expenses

 

453,393

 

442,404

 

10,989

 

2.5

%

 

 

 

 

 

 

 

 

 

 

Operating income

 

191,332

 

192,173

 

(841

)

(0.4

)%

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

2,137

 

839

 

1,298

 

154.7

%

Interest expense

 

(137,506

)

(129,912

)

7,594

 

5.8

%

Loss on asset impairment

 

(21,491

)

 

21,491

 

100.0

%

(Loss) gain on early extinguishment of debt

 

(1,044

)

20,686

 

(21,730

)

(105.0

)%

Equity in earnings of equity investments

 

6,643

 

3,818

 

2,825

 

74.0

%

Gain on issuance of shares by equity investee

 

34,808

 

 

34,808

 

100.0

%

Gain on sale of properties

 

34,336

 

 

34,336

 

100.0

%

Income from continuing operations before income tax expense

 

109,215

 

87,604

 

21,611

 

24.7

%

Income tax expense

 

(329

)

(518

)

(189

)

(36.5

)%

Income from continuing operations

 

108,886

 

87,086

 

21,800

 

25.0

%

Discontinued operations:

 

 

 

 

 

 

 

 

 

(Loss) income from discontinued operations

 

(349

)

8,684

 

(9,033

)

(104.0

)%

Gain on sale of properties

 

4,568

 

79,157

 

(74,589

)

(94.2

)%

Net income

 

113,105

 

174,927

 

(61,822

)

(35.3

)%

Preferred distributions

 

(38,001

)

(38,001

)

 

%

Net income available for common shareholders

 

$

75,104

 

$

136,926

 

$

(61,822

)

(45.1

)%

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic

 

62,198

 

56,085

 

6,113

 

10.9

%

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — diluted

 

69,496

 

63,383

 

6,113

 

9.6

%

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations available for common shareholders

 

$

1.14

 

$

0.88

 

$

0.26

 

29.5

%

Income from discontinued operations

 

$

0.07

 

$

1.57

 

$

(1.50

)

(95.5

)%

Net income available for common shareholders

 

$

1.21

 

$

2.44

 

$

(1.23

)

(50.4

)%

 

24



Table of Contents

 

Rental income.  Rental income increased for the nine months ended September 30, 2010, compared to the same period in 2009, primarily due to an increase in rental income from our Metro Denver, CO and Other Markets segments, offset by decreases in rental income from our Metro Washington, DC and Metro Boston, MA segments, as described in the segment information note to our condensed consolidated financial statements.  The aggregate increase primarily reflects the acquisition of 28 properties in 2009 and 2010, offset by a decrease in rental income from the contribution of 29 properties to GOV in 2009, the sale of 15 properties to GOV in 2010 and the decline in occupancy in 2010.  Rental income from our Metro Denver, CO segment increased by $12.4 million, or 66.8%, primarily reflecting the acquisition of two properties in 2009 and 2010, offset by the contribution of three properties in that segment to GOV in June 2009.  Rental income from our Other Markets segment increased $9.2 million, or 2.4%, primarily reflecting the acquisition of 22 properties during 2009 and 2010, offset by a $21.8 million decrease in rental income resulting from the contribution of 22 properties to GOV in June 2009 and the sale of 11 properties to GOV in 2010, and the decline in occupancy primarily from properties we owned continuously since January 1, 2009.  Rental income from our Metro Washington, DC segment decreased by $8.9 million, or 19.4%, primarily reflecting the contribution of four properties to GOV in June 2009 and the sale of two properties to GOV in 2010, offset by an increase in rental income from two properties acquired during 2009 and two properties acquired during 2010.  Rental income from our Metro Boston, MA segment decreased $2.2 million, or 5.7%, primarily reflecting the sale of two properties to GOV in 2010 and the decline in occupancy in 2010.  Rental income includes non-cash straight line rent adjustments totaling $8.1 million in 2010 and $6.6 million in 2009 and amortization of acquired real estate leases and obligations totaling ($5.2) million in 2010 and ($8.1) million in 2009.  Rental income also includes lease termination fees totaling $1.8 million in 2010 and $1.1 million in 2009.

 

Total expenses.  The increase in total expenses primarily reflects the acquisition of properties during 2009 and 2010, offset by the contribution of 29 properties to GOV in June 2009 and the sale of 15 properties to GOV during 2010.  The increase in general and administrative expenses is also attributable to an increase in legal fees associated with our industrial and commercial land in Hawaii.

 

Interest and other income.  The increase in interest and other income in 2010 primarily reflects a $750,000 nonrefundable deposit that was forfeited by the buyer of one of our properties when the buyer was unable to meet its obligation to purchase the property in January 2010 and the recognition of $376,000 of unamortized interest income from our investment in marketable pass through certificates.

 

Interest expense.  The increase in interest expense in 2010 primarily reflects the issuance during the fourth quarter of 2009 of $125.0 million of 7.50% unsecured senior notes and $175.0 million of mortgage debt with a current interest rate of 5.66%, the repurchase and retirement of $117 million of our debt early in 2009, the prepayment of $266.7 million of mortgage debt and the repayment of $30.0 million of 8.875% senior notes in 2010.

 

Loss on asset impairment.  The loss on asset impairment in 2010 reflects the write down to the sales price less costs to sell of four office properties that we sold to GOV.

 

(Loss) gain on early extinguishment of debt.  The loss on early extinguishment of debt in 2010 is from the write off of unamortized discounts and deferred financing fees associated with the prepayment of $266.7 million of mortgage debt in August 2010.  The gain on early extinguishment of debt in 2009 relates to the repurchase and retirement of $31.8 million of our floating rate senior notes due in 2011 for $24.2 million, $49.3 million of our 6.95% senior notes due in 2012 for $41.5 million, $9.0 million of our 6.50% senior notes due in 2013 for $7.3 million, $5.3 million of our 5.75% senior notes due in 2014 for $4.3 million and $14.0 million of our 6.40% senior notes due in 2015 for $11.0 million, net of unamortized deferred financing fees and note discounts.

 

Equity in earnings of equity investments.  Equity in earnings of equity investments represents our proportionate share of earnings (loss) from AIC and from GOV.  The increase in earnings from equity investments primarily reflects our ownership interest in GOV since its formation in June 2009.

 

Gain on issuance of shares by equity investee.  The gain on issuance of shares by equity investee reflects the issuance of 9,775,000 common shares by GOV in January 2010 and the issuance of 9,200,000 common shares by GOV in August 2010 at prices above our per share carrying value.

 

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Table of Contents

 

Gain on sale of properties from continuing operations.  Net sales proceeds and gains from the sale of 15 office properties to GOV in 2010 were $229.4 million and $34.3 million, respectively.

 

Income from continuing operations.  The increase in income from continuing operations is due primarily to the gain on issuance of shares by GOV in 2010, gains on sale of properties in 2010, and income from acquisitions made during 2009 and 2010, offset by an increase in interest expense and the loss on asset impairment and decline in occupancy in 2010, the contribution of 29 properties to GOV in June 2009, the sale of 15 properties to GOV in 2010 and the gain on early extinguishment of debt in 2009.

 

Income from discontinued operations.  Income from discontinued operations reflects operating results from ten office properties sold during 2009, one office property sold in 2010 and one office property classified as held for sale as of September 30, 2010.  The properties contributed or sold to GOV are not considered discontinued operations because of our continuing ownership of GOV.

 

Gain on sale of properties from discontinued operations.  Net sales proceeds and gain from the sale of one office property in 2010 were $1.5 million and $4.6 million, respectively.  Net sales proceeds and gains from the sale of ten office properties in 2009 were $212.1 million and $79.2 million, respectively.

 

Net income and net income available for common shareholders.  The decrease in net income and net income available for common shareholders is due primarily to the loss on asset impairment in 2010, gains on the sale of properties and early extinguishment of debt recognized in 2009 compared to 2010, a decrease in rents resulting from the contribution of 29 properties to GOV in June 2009, a decrease in rents from properties sold in 2009 and 2010, an increase in interest expense and the decline in occupancy in 2010, offset by the gain recognized on the issuance of common shares by GOV and income from acquisitions made during 2009 and 2010.  Net income available for common shareholders is net income reduced by preferred distributions.

 

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Table of Contents

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our Operating Liquidity and Resources

 

Our principal source of funds to pay operating expenses, debt obligations and distributions on our common and preferred shares is rental income from our properties and distributions from our equity investment in GOV.  This flow of funds has historically been sufficient for us to pay our operating expenses, debt service and distributions to shareholders.  We believe that our operating cash flow will be sufficient to meet our operating expenses, debt service and distribution payments for the foreseeable future.  Our future cash flows from operating activities will depend primarily upon our:

 

·                  ability to maintain or improve the occupancy of, and the current rent rates at, our properties;

 

·                  ability to control operating cost increases at our properties;

 

·                  receipt of distributions from our equity investment in GOV; and

 

·                  ability to purchase additional properties which produce positive cash flows from operations.

 

We believe that present leasing market conditions in the majority of areas where our properties are located may result in decreases in occupancies and effective rents, or gross rents less amortization of landlord funded tenant improvements and leasing costs.  Also, volatility in energy costs may also cause our future operating costs to fluctuate; however, the impact of these fluctuations is expected to be partially offset by the pass throughs of operating costs to our tenants pursuant to lease terms.  We generally do not purchase turnaround properties or properties which do not generate positive cash flows.  Our future purchases of properties which generate positive cash flows cannot be accurately projected because such purchases depend upon available opportunities which come to our attention.

 

Cash flows provided by (used in) operating, investing and financing activities were $198.4 million, ($164.0) million and $122.1 million, respectively, for the nine months ended September 30, 2010, and $233.6 million, ($270.4) million and $54.5 million, respectively, for the nine months ended September 30, 2009.  Changes in all three categories between 2010 and 2009 are primarily related to property acquisitions and sales, repayments and issuances of debt obligations in 2009 and 2010, and net proceeds received from the issuance of 16,125,000 of our common shares during 2010.

 

Our Investment and Financing Liquidity and Resources

 

In order to fund acquisitions and to accommodate cash needs that may result from timing differences between our receipt of rents and our desire or need to make distributions or pay operating or capital expenses, we maintain a $750.0 million unsecured revolving credit facility with a group of institutional lenders.  In August 2010, we entered a new $750.0 million unsecured revolving credit facility.  The new facility replaces our previous $750.0 million unsecured revolving credit facility, which had a maturity date of August 22, 2010.  The maturity date of the new facility is August 8, 2013 and includes an option for us to extend the facility for one year to August 8, 2014.  The new facility also includes a feature under which the maximum borrowing may be increased to up to $1.5 billion in certain circumstances.  At September 30, 2010, zero was outstanding and $750.0 million was available under our revolving credit facility.  We also had cash and cash equivalents of $174.7 million, reflecting excess proceeds received from our public offering of 7,500,000 common shares completed in September 2010.  We expect to use cash balances, borrowings under our credit facility, proceeds from the sale of properties, distributions from our equity investment in GOV and net proceeds from offerings of equity or debt securities to fund continuing operations and future property acquisitions.

 

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Table of Contents

 

Our outstanding debt maturities and weighted average interest rates as of September 30, 2010 were as follows (dollars in thousands):

 

 

 

Scheduled Principal Payments During Period

 

 

 

 

 

Secured

 

Unsecured

 

Unsecured

 

 

 

Weighted

 

 

 

Fixed Rate

 

Floating

 

Fixed

 

 

 

Average

 

Year

 

Debt

 

Rate Debt

 

Rate Debt

 

Total (1)

 

Interest Rate

 

2010

 

$

1,113

 

$

 

$

20,000

 

$

21,113

 

8.5

%

2011

 

33,590

 

168,219

 

 

201,809

 

2.0

%

2012

 

31,492

 

 

150,680

 

182,172

 

7.0

%

2013

 

5,779

 

 

190,980

 

196,759

 

6.5

%

2014

 

17,876

 

 

244,655

 

262,531

 

5.7

%

2015

 

13,543

 

 

436,000

 

449,543

 

6.0

%

2016

 

59,768

 

 

400,000

 

459,768

 

6.2

%

2017

 

4,939

 

 

250,000

 

254,939

 

6.2

%

2018

 

5,283

 

 

250,000

 

255,283

 

6.6

%

2019 and thereafter

 

184,496

 

 

375,000

 

559,496

 

6.2

%

 

 

$

357,879

 

$

168,219

 

$

2,317,315

 

$

2,843,413

 

6.0

%

 


(1) Total debt as of September 30, 2010, net of unamortized premiums and discounts, was $2,826,691.

 

In August 2010, we repaid at maturity all $30.0 million of our 8.875% senior notes due in 2010.  We also prepaid at par $266.7 million of mortgage debt that was scheduled to mature in 2011 and 2029.  In connection with the prepayment of this mortgage debt, we recorded a loss on early extinguishment of debt of $1.0 million from the write off of unamortized discounts and deferred financing fees during the third quarter of 2010.  We funded these payments with borrowings under our revolving credit facility.  In October 2010, we repaid at maturity all $20.0 million of our 8.625% senior notes due in 2010 using cash on hand.

 

In September 2010, we issued $250.0 million of unsecured senior notes in a public offering, raising net proceeds of approximately $242.5 million.  These notes bear interest at 5.875% per annum, require semi-annual interest payments and mature in September 2020.  Net proceeds from these notes were used to repay amounts then outstanding under our revolving credit facility.

 

When significant amounts are outstanding under our revolving credit facility or as the maturity dates of our revolving credit facility and term debts approach, we explore alternatives for the repayment of amounts due.  Such alternatives may include incurring additional debt and issuing new equity securities.  We have an effective shelf registration statement that allows us to issue public securities on an expedited basis, but it does not assure that there will be buyers for such securities.

 

We believe we will have access to various types of financings, including debt or equity offerings, to fund our future acquisitions and to pay our debts and other obligations as they become due.  The completion and the costs of our future debt transactions will depend primarily upon market conditions and our credit ratings.  We have no control over market conditions.  Our credit ratings depend upon evaluations by credit rating agencies of our business practices and plans and, in particular, whether we appear to have the ability to maintain our earnings, to space our debt maturities and to balance our use of debt and equity capital so that our financial performance and leverage ratios afford us flexibility to withstand any reasonably anticipatable adverse changes.  We intend to conduct our business activities in a manner which will continue to afford us reasonable access to capital for investment and financing activities.  However, there can be no assurance that we will be able to complete any debt or equity offerings or that our cost of any future public or private financings will not increase.

 

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Table of Contents

 

On June 14, 2010, our board of trustees approved a reverse stock split that resulted in a one for four combination of our common shares of beneficial interest, $0.01 par value per share, effective July 1, 2010.  The reverse stock split reduced the number of our issued and outstanding common shares from 258,385,241 to 64,596,311.  The number of our authorized common shares did not change.  As required, common share amounts presented for all periods have been restated to reflect the reverse stock split.  As a result of the reverse stock split, the conversion rate of our 15,180,000 outstanding series D cumulative convertible preferred shares, or series D preferred shares, automatically changed from 1.9231 common shares per series D preferred share to 0.480775 common share per series D preferred share (the equivalent of a change in conversion price from $13.00 per common share to $52.00 per common share).

 

During the nine months ended September 30, 2010, we received cash distributions totaling $12.0 million from GOV.  At September 30, 2010, we owned 9,950,000, or 24.6%, of the common shares of beneficial interest of GOV with a carrying value of $168.7 million and a market value, based on quoted market prices, of $265.7 million ($26.70 per share).  During 2010, GOV completed public offerings of 18,975,000 common shares, reducing our ownership percentage in GOV from 46.3% to 24.6%, and we recognized gains totaling $34.8 million.

 

In June 2010, we entered agreements to sell 15 properties to GOV with approximately 1.9 million square feet.  We sold all 15 of these properties for an aggregate sales price of $231.0 million, excluding closing costs, and recognized gains totaling $34.3 million, exclusive of deferred gains of $14.6 million attributable to our ownership interest in GOV.  In connection with GOV’s IPO, we and GOV entered into a transaction agreement in which, among other things, we granted GOV the right of first refusal to acquire any property owned by us that we determine to divest if the property is then majority leased to a government tenant, including these 15 properties.  These transactions were negotiated by special committees of our and GOV’s boards of trustees composed solely of independent trustees who are not also trustees of the other party.

 

In September 2010, we sold an office property located in Irondequoit (Rochester), NY with approximately 310,000 square feet for $9.8 million, excluding closing costs.  In connection with this sale, we provided mortgage financing to the buyer, a not for profit hospital entity, totaling $8.3 million at 4.75% per annum and recognized a gain on sale of $4.6 million during the three months ended September 30, 2010.

 

During 2010, we acquired 32 properties for aggregate purchase prices of $552.6 million, excluding closing costs, using cash on hand, borrowings under our revolving credit facility, proceeds from the sales of properties and proceeds from our common share and senior notes offerings.  We also entered agreements to acquire seven additional properties.  Details of these transactions are as follows:

 

In April 2010, we acquired an office property located in Denver, CO with 248,493 square feet.  This property is 100% leased to RE/MAX Realty as its corporate headquarters through April 2028.  The purchase price was $75.0 million, excluding closing costs.

 

In April 2010, we acquired an office property located in Colorado Springs, CO with 77,411 square feet.  The property is 100% leased to two tenants for a weighted (by rents) average lease term of 4.7 years.  The purchase price was $10.8 million, excluding closing costs.

 

In June 2010, we acquired two office properties located in Ann Arbor, MI with a combined 410,410 square feet.  These properties are 88% leased to 16 tenants for a weighted (by rents) average lease term of 7.6 years.  The aggregate purchase price was $65.2 million, excluding closing costs.

 

In June 2010, we acquired two office properties located in Carson, CA with a combined 212,000 square feet.  These properties are 100% leased to Northrop Grumman for 6.2 years.  The aggregate purchase price was $27.9 million, excluding closing costs.

 

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Table of Contents

 

In July 2010, we acquired two office properties located in Stafford, VA with a combined 117,949 square feet.  These properties are 90% leased to ten tenants for a weighted (by rents) average lease term of 2.8 years.  The aggregate purchase price was $18.8 million, excluding closing costs.

 

In August 2010, we acquired one office property located in Milwaukee, WI with 432,092 square feet.  This property is 93% leased to 29 tenants for a weighted (by rents) average lease term of 4.3 years.  The purchase price was $80.2 million, excluding closing costs.

 

In August 2010, we acquired seven properties located in Monterey, CA.  These properties are 100% leased to The Wine Group for 16.0 years.  The aggregate purchase price was $28.0 million, excluding closing costs.

 

In September 2010, we acquired one office property located in Greensboro, NC with 323,773 square feet.  This property is 86% leased for an average lease term of 5.0 years.  The purchase price was $44.7 million, excluding closing costs.

 

In October 2010, we acquired MacarthurCook Industrial Property Fund, or MIF, an Australian property trust that owns 10 industrial properties with approximately 1.4 million square feet.  These properties are 90% leased to 14 tenants for a weighted (by rents) average lease term of 4.7 years.  The MIF properties are located in five Australian states: New South Wales (3 properties), Victoria (2 properties), Western Australia (2 properties), Tasmania (2 properties) and Queensland (1 property).  The aggregate purchase price for these properties was approximately $83.2 million, excluding acquired positive working capital and closing costs.

 

In October 2010, we acquired three office properties located in Carson, CA with a combined 190,000 square feet.  These properties are 100% leased to Northrop Grumman for 6.0 years.  The aggregate purchase price was $22.7 million, excluding closing costs.

 

In October 2010, we acquired a two tower office property located in Chicago, IL with 631,445 square feet.  This property is 90% leased to 33 tenants for a weighted (by rents) average lease term of 7.3 years.  The purchase price was $96.3 million, excluding closing costs.

 

In October 2010, we entered a purchase and sale agreement to acquire seven office properties located in Birmingham, AL with a combined 904,109 square feet.  We expect to acquire these properties during the fourth quarter of 2010; however, this acquisition is subject to customary closing conditions and no assurance can be given that this acquisition will be consummated in that time period or at all.

 

During the three and nine months ended September 30, 2010 and 2009, cash expenditures made and capitalized for tenant improvements, leasing costs, building improvements and development and redevelopment activities were as follows (amounts in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Tenant improvements

 

$

9,803

 

$

8,727

 

$

24,965

 

$

18,812

 

Leasing costs

 

580

 

5,884

 

8,853

 

9,743

 

Building improvements (1)

 

2,918

 

1,563

 

4,621

 

8,931

 

Development and redevelopment activities (2)

 

5,942

 

3,305

 

14,013

 

7,741

 

 


(1)

Building improvements generally include construction costs, expenditures to replace obsolete building components, and expenditures that extend the useful life of existing assets.

(2)

Development, redevelopment and other activities generally include non-recurring expenditures or expenditures that we believe increase the value of our existing properties.

 

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Commitments made for expenditures in connection with leasing space during the three months ended September 30, 2010 are as follows (amounts in thousands, except as noted):

 

 

 

New
Leases (1)

 

Renewals (1)

 

Total

 

Square feet leased during the year

 

733

 

1,287

 

2,020

 

Total commitments for tenant improvements and leasing costs

 

$

19,427

 

$

6,911

 

$

26,338

 

Leasing costs per square foot (whole dollars)

 

$

26.50

 

$

5.37

 

$

13.04

 

Average lease term (years)

 

6.8

 

5.2

 

5.8

 

Leasing costs per square foot per year (whole dollars)

 

$

3.90

 

$

1.03

 

$

2.25

 

 


(1)  Excludes properties classified in discontinued operations.

 

We have no commercial paper, swaps, hedges, or off balance sheet arrangements as of September 30, 2010 except the interest hedge associated with a $175.0 million mortgage loan described in Notes 8 and 9 in the notes to our condensed consolidated financial statements appearing above.

 

Debt Covenants

 

Our principal debt obligations at September 30, 2010 were our unsecured revolving credit facility and our $2.5 billion of publicly issued unsecured term debt.  Our publicly issued debt is governed by an indenture.  Our public debt indenture and related supplements and our revolving credit facility agreement contain a number of financial ratio covenants which generally restrict our ability to incur debts, including debts secured by mortgages on our properties, in excess of calculated amounts, require us to maintain a minimum net worth, restrict our ability to make distributions under certain circumstances and require us to maintain other financial ratios.  At September 30, 2010, we believe we were in compliance with all of our covenants under our indenture and related supplements and our revolving credit facility agreement.

 

In addition to our unsecured debt obligations, we had $352.6 million of mortgage notes outstanding at September 30, 2010.

 

None of our indenture and related supplements, our revolving credit facility or our mortgage notes contain provisions for acceleration or require us to provide collateral security which could be triggered by our debt ratings.  However, our senior debt rating is used to determine the interest rate and the fees payable under our revolving credit facility.

 

Our public debt indenture and related supplements contain cross default provisions to any other debts of $20.0 million or more.  Similarly, our revolving credit facility contains cross default provisions.  Any termination of our business management agreement with RMR would cause a default under our revolving credit facility, if not approved by a majority of our lenders.

 

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Related Person Transactions

 

As discussed above, we own 9,950,000, or approximately 24.6%, of the common shares of beneficial interest of GOV, with a carrying value of $168.7 million and a market value, based on quoted market prices, of $265.7 million ($26.70 per share) as of September 30, 2010.  GOV is a REIT which owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its IPO in June 2009 when it became a separate publicly owned entity.  Both we and GOV are managed by RMR, and our Managing Trustees are also the Managing Trustees of GOV.

 

In June 2010, we entered agreements to sell 15 properties to GOV with approximately 1.9 million square feet.  We sold all 15 of these properties for an aggregate sales price of $231.0 million, excluding closing costs.  In connection with GOV’s IPO, we and GOV entered into a transaction agreement in which, among other things, we granted GOV the right of first refusal to acquire any property owned by us that we determine to divest if the property is then majority leased to a government tenant, including these 15 properties.  These transactions were negotiated by special committees of our and GOV’s boards of trustees composed solely of independent trustees who are not also trustees of the other party.

 

We have no employees.  Instead, services that might be provided to us by employees are provided to us by RMR.  RMR provides both business and property management services to us under a business management agreement and a property management agreement, each as extended and amended. Information regarding an amendment to our business management agreement entered into on October 29, 2010, appears in Item 5 of Part II of this Report.  During the three months ended September 30, 2010 and 2009, our fees to RMR under these agreements were $15.5 million and $14.6 million, respectively.  During the nine month periods ended September 30, 2010 and 2009, these fees totaled $45.9 million and $47.4 million, respectively.

 

As of September 30, 2010, we have invested approximately $5.2 million in AIC with RMR and other companies to which RMR provides management services.  We own approximately 14.3% of AIC.  All of our trustees are also directors of AIC, and RMR provides certain management services to AIC.  During the three and nine months ended September 30, 2010, we recognized earnings and (losses) of approximately $35,000 and ($17,000), respectively, related to this investment.  In June 2010, we, RMR and other companies to which RMR provides management services purchased property insurance pursuant to an insurance program arranged by AIC.  Our annual premiums for this property insurance are expected to be approximately $5.3 million.  We are currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance.

 

For more information about our related person transactions, including our dealings with GOV, RMR, AIC and our Managing Trustees and their affiliates, and about the risks which may arise as a result of these and other related person transactions, please see the notes to our consolidated financial statements appearing elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2009, and our other filings made with the SEC and in particular the sections captioned “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Related Person Transactions” in our Annual Report and the section captioned “Related Person Transactions and Company Review of Such Transactions” in our Proxy Statement dated February 23, 2010 relating to our 2010 Annual Meeting of Shareholders and Item 1.01 in our Current Report on Form 8-K dated January 27, 2010 and our Current Report on Form 8-K filed with the SEC on June 18, 2010.

 

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

We are exposed to risks associated with market changes in interest rates.  We manage our exposure to this market risk by monitoring available financing alternatives.  Our strategy to manage exposure to changes in interest rates is unchanged from December 31, 2009.  Other than as described below, we do not foresee any significant changes in our exposure to fluctuations in interest rates or in how we manage this exposure in the near future.

 

At September 30, 2010, our total outstanding fixed rate term debt consisted of the following fixed rate notes:

 

Amount

 

Coupon

 

Maturity

 

 

 

 

 

 

 

Unsecured senior notes:

 

 

 

 

 

 

 

 

 

 

 

  $20.0 million

 

8.625

%

2010

(1)

$150.7 million

 

6.950

%

2012

 

$191.0 million

 

6.500

%

2013

 

$244.7 million

 

5.750

%

2014

 

$186.0 million

 

6.400

%

2015

 

$250.0 million

 

5.750

%

2015

 

$400.0 million

 

6.250

%

2016

 

$250.0 million

 

6.250

%

2017

 

$250.0 million

 

6.650

%

2018

 

$125.0 million

 

7.500

%

2019

 

$250.0 million

 

5.875

%

2020

 

 

No principal repayments are due under our unsecured senior notes until maturity.

 

 

 

 

 

 

 

Secured notes:

 

 

 

 

 

 

 

 

 

 

 

$29.6 million

 

7.435

%

2011

 

$23.6 million

 

8.050

%

2012

 

  $4.8 million

 

6.000

%

2012

 

$13.0 million

 

4.950

%

2014

 

  $8.9 million

 

5.990

%

2015

 

  $8.3 million

 

5.760

%

2016

 

$41.6 million

 

6.030

%

2016

 

$12.3 million

 

7.360

%

2016

 

$175.0 million

 

2.885

%(2)

2019

 

  $4.4 million

 

6.750

%

2022

 

$14.6 million

 

6.140

%

2023

 

  $8.5 million

 

5.710

%

2026

 

$13.5 million

 

6.060

%

2027

 

 


(1)          This loan was repaid at maturity in October 2010.

(2)          Interest on this loan is payable at a spread over LIBOR but has been fixed through December 1, 2016 by an interest rate hedge which sets the rate at approximately 5.66%.  The coupon rate represents the floating interest rate at September 30, 2010.

 

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As of September 30, 2010, our secured notes are secured by 15 of our properties and require principal and interest payments through maturity pursuant to amortization schedules.  We have interest rate swap agreements to manage our interest rate risk exposure on $175.0 million of mortgage notes due 2019, which requires interest at a spread over LIBOR.  The interest rate swap agreements utilized by us effectively modify our exposure to interest rate risk arising from this floating rate mortgage loan by converting this floating rate debt to a fixed rate through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  These agreements involve the receipt of floating rate amounts in exchange for fixed rate interest payments over the life of the agreements.  Approximately 6.2% ($175.0 million) of our total outstanding debt had interest payments designated as hedged transactions to interest rate swap agreements at September 30, 2010.  The total notional amounts of our receive variable/pay fixed interest rate swaps designated as hedging instruments was $175.0 million.  As of September 30, 2010, the fair value of our derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive loss in our consolidated balance sheets totaled ($13,418).

 

Because our fixed rate unsecured and secured notes bear interest at fixed rates, changes in market interest rates during the term of these debts will not affect our operating results.  If all of our fixed rate unsecured and secured notes outstanding at September 30, 2010 were to be refinanced at interest rates which are 10% higher or lower than shown above, our per annum interest cost would increase or decrease, respectively, by approximately $16.8 million.

 

Changes in market interest rates would affect the fair value of our fixed rate debt obligations; increases in market interest rates decrease the fair value of our fixed rate debt, while decreases in market interest rates increase the value of our fixed rate debt.  Based on the balances outstanding at September 30, 2010 and discounted cash flow analyses, a hypothetical immediate 10% change in interest rates would change the fair value of our fixed rate unsecured and secured debt obligations by approximately $63 million.

 

Each of our fixed rate unsecured and secured debt arrangements allows us to make repayments earlier than the stated maturity date.  In some cases, we are not allowed to make early repayment prior to a cutoff date and in most cases we are allowed to make prepayments only at a premium equal to a make whole amount, as defined, generally designed to preserve a stated yield to the note holder.  These prepayment rights may afford us the opportunity to mitigate the risk of refinancing at maturity at higher rates by refinancing prior to maturity.  The majority of our fixed rate senior unsecured notes are publicly traded, and we have in the past and may in the future occasionally take advantage of market opportunities to repurchase notes, which will also mitigate future refinancing risks.

 

Although we have no present plans to do so, we may in the future enter other hedge arrangements to mitigate our exposure to changes in interest rates.

 

At September 30, 2010, zero was outstanding and $750.0 million was available for drawing under our unsecured revolving credit facility and $168.2 million of our floating rate senior unsecured notes were outstanding.  Our floating rate senior unsecured notes mature in March 2011.  Our revolving credit facility matures in August 2013 and includes an option for us to extend the maturity by one year to August 2014.  Repayments under our revolving credit facility may be made at any time without penalty.  Repayments under our floating rate senior unsecured notes may also be made without penalty.  We borrow in U.S. dollars and borrowings under our revolving credit facility and our floating rate senior unsecured notes require interest at LIBOR plus a premium.  Accordingly, we are vulnerable to changes in U.S. dollar based short term rates, specifically LIBOR.  For example, the weighted average interest rate payable on our revolver and floating rate senior unsecured notes was 1.2% during the nine months ended September 30, 2010.  A change in interest rates would not affect the value of these floating rate unsecured debts but would affect our operating results.  The following table presents the impact a 10% change in interest rates would have on our floating rate interest expense as of September 30, 2010 (dollars in thousands):

 

 

 

Impact of Changes in Interest Rates

 

 

 

Interest Rate
Per Year

 

Outstanding
Debt

 

Total Interest
Expense
Per Year

 

 

 

 

 

 

 

 

 

At September 30, 2010

 

1.2

%

$

168,219

 

$

2,019

 

10% reduction

 

1.1

%

$

168,219

 

$

1,850

 

10% increase

 

1.3

%

$

168,219

 

$

2,187

 

 

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The foregoing table shows the impact of an immediate change in floating interest rates.  If interest rates were to change gradually over time, the impact would be spread over time.  Our exposure to fluctuations in floating interest rates will increase or decrease in the future with increases or decreases in the outstanding amount of our revolving credit facility or other floating rate debt, unless we enter hedge arrangements.

 

Item 4.  Controls and Procedures

 

As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of our Managing Trustees, President and Chief Investment Officer and Treasurer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended, Rules 13a-15 and 15d-15. Based upon that evaluation, our Managing Trustees, President and Chief Investment Officer and Treasurer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

 

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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WARNING CONCERNING FORWARD LOOKING STATEMENTS

 

THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS STATEMENTS WHICH CONSTITUTE FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND OTHER FEDERAL SECURITIES LAWS. WHENEVER WE USE WORDS SUCH AS “BELIEVE”, “EXPECT”, “ANTICIPATE”, “INTEND”, “PLAN”, “ESTIMATE” OR SIMILAR EXPRESSIONS, WE ARE MAKING FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS AND THEIR IMPLICATIONS ARE BASED UPON OUR PRESENT INTENT, BELIEFS OR EXPECTATIONS, BUT FORWARD LOOKING STATEMENTS AND THEIR IMPLICATIONS ARE NOT GUARANTEED TO OCCUR AND MAY NOT OCCUR. FORWARD LOOKING STATEMENTS IN THIS REPORT RELATE TO VARIOUS ASPECTS OF OUR BUSINESS, INCLUDING:

 

·                  THE CREDIT QUALITY OF OUR TENANTS,

 

·                  THE LIKELIHOOD THAT OUR TENANTS WILL PAY RENT, RENEW LEASES, SIGN NEW LEASES OR BE AFFECTED BY CYCLICAL ECONOMIC CONDITIONS,

 

·                  OUR ACQUISITIONS AND SALES OF PROPERTIES,

 

·                  OUR ABILITY TO COMPETE FOR ACQUISITIONS AND TENANCIES EFFECTIVELY,

 

·                  OUR ABILITY TO PAY INTEREST ON AND PRINCIPAL OF OUR DEBT,

 

·                  OUR ABILITY TO PAY DISTRIBUTIONS TO SHAREHOLDERS AND THE AMOUNT OF SUCH DISTRIBUTIONS,

 

·                  OUR POLICIES AND PLANS REGARDING INVESTMENTS AND FINANCINGS,

 

·                  THE FUTURE AVAILABILITY OF BORROWINGS UNDER OUR REVOLVING CREDIT FACILITY,

 

·                  OUR TAX STATUS AS A REIT,

 

·                  OUR ABILITY TO RAISE EQUITY OR DEBT,

 

·                  OUR EXPECTATION THAT WE WILL BENEFIT FINANCIALLY BY PARTICIPATING IN THE INSURANCE COMPANY WITH RMR AND COMPANIES TO WHICH RMR PROVIDES MANAGEMENT SERVICES, AND

 

·                  OTHER MATTERS.

 

OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY OUR FORWARD LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. FACTORS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FORWARD LOOKING STATEMENTS AND UPON OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION, CASH FLOWS, LIQUIDITY AND PROSPECTS INCLUDE, BUT ARE NOT LIMITED TO:

 

·                  THE IMPACT OF CHANGES IN THE ECONOMY AND THE CAPITAL MARKETS ON US AND OUR TENANTS,

 

·                  COMPETITION WITHIN THE REAL ESTATE INDUSTRY OR THOSE INDUSTRIES IN WHICH OUR TENANTS OPERATE,

 

·                  ACTUAL AND POTENTIAL CONFLICTS OF INTEREST WITH OUR MANAGING TRUSTEES, GOV, RMR AND THEIR AFFILIATES,

 

·                  COMPLIANCE WITH, AND CHANGES TO, FEDERAL, STATE AND LOCAL LAWS AND REGULATIONS, ACCOUNTING RULES, TAX RATES AND SIMILAR MATTERS, AND

 

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Table of Contents

 

·                  LIMITATIONS IMPOSED ON OUR BUSINESS AND OUR ABILITY TO SATISFY COMPLEX RULES IN ORDER FOR US TO QUALIFY AS A REIT FOR U.S. FEDERAL INCOME TAX PURPOSES.

 

FOR EXAMPLE:

 

·                  IF THE AVAILABILITY OF DEBT CAPITAL BECOMES MORE RESTRICTED, WE MAY BE UNABLE TO REFINANCE OR REPAY OUR DEBT OBLIGATIONS WHEN THEY BECOME DUE OR ON TERMS WHICH ARE AS FAVORABLE AS WE NOW HAVE,

 

·                  THE CURRENT HIGH UNEMPLOYMENT RATE IN THE U.S. MAY CONTINUE FOR A LONG TIME OR BECOME WORSE IN THE FUTURE.  SUCH CIRCUMSTANCES MAY FURTHER REDUCE DEMAND FOR LEASING OFFICE AND INDUSTRIAL SPACE.  IF THE DEMAND FOR LEASING OFFICE AND INDUSTRIAL SPACE REMAINS AT CURRENT LEVELS OR BECOMES FURTHER DEPRESSED, OCCUPANCY AND OPERATING RESULTS OF OUR PROPERTIES MAY DECLINE,

 

·                  SOME OF OUR TENANTS MAY NOT RENEW EXPIRING LEASES, AND WE MAY BE UNABLE TO LOCATE NEW TENANTS TO MAINTAIN THE HISTORICAL OCCUPANCY RATES OF OUR PROPERTIES,

 

·                  OUR AGREEMENTS TO ACQUIRE AND SELL PROPERTIES ARE SUBJECT TO VARIOUS TERMS AND CONDITIONS, AND THESE TERMS AND CONDITIONS MAY NOT BE MET.  AS A RESULT, SOME OR ALL OF THESE TRANSACTIONS MAY NOT OCCUR OR MAY BE DELAYED,

 

·                  OUR ABILITY TO MAKE FUTURE DISTRIBUTIONS DEPENDS UPON A NUMBER OF FACTORS, INCLUDING OUR FUTURE EARNINGS. WE MAY BE UNABLE TO MAINTAIN OUR CURRENT RATE OF DISTRIBUTIONS ON OUR COMMON SHARES OR PREFERRED SHARES AND FUTURE DISTRIBUTIONS MAY BE SUSPENDED OR PAID AT A LESSER RATE THAN THE DISTRIBUTIONS WE NOW PAY,

 

·                  OUR ABILITY TO GROW OUR BUSINESS AND INCREASE OUR DISTRIBUTIONS DEPENDS IN LARGE PART UPON OUR ABILITY TO BUY PROPERTIES AND LEASE THEM FOR RENTS THAT EXCEED OUR CAPITAL COSTS. WE MAY BE UNABLE TO IDENTIFY PROPERTIES THAT WE WANT TO ACQUIRE OR TO NEGOTIATE ACCEPTABLE PURCHASE PRICES, ACQUISITION FINANCING OR LEASE TERMS FOR NEW PROPERTIES,

 

·                  THE DISTRIBUTIONS WE RECEIVE FROM GOV MAY DECLINE OR WE MAY BE UNABLE TO SELL OUR GOV SHARES FOR AN AMOUNT EQUAL TO OUR CARRYING VALUE OF THOSE SHARES, AND

 

·                  OUR PARTICIPATION IN AIC INVOLVES POTENTIAL FINANCIAL RISKS AND REWARDS TYPICAL OF ANY START UP BUSINESS VENTURE AS WELL AS OTHER FINANCIAL RISKS AND REWARDS SPECIFIC TO INSURANCE COMPANIES.  ACCORDINGLY, OUR EXPECTED FINANCIAL BENEFITS FROM OUR INITIAL OR FUTURE INVESTMENTS IN AIC MAY BE DELAYED OR MAY NOT OCCUR.

 

THESE RESULTS COULD OCCUR DUE TO MANY DIFFERENT CIRCUMSTANCES, SOME OF WHICH ARE BEYOND OUR CONTROL, SUCH AS CHANGES IN OUR TENANTS’ FINANCIAL CONDITIONS OR THE MARKET DEMAND FOR LEASED SPACE, OR CHANGES IN CAPITAL MARKETS OR THE ECONOMY GENERALLY.

 

THE INFORMATION CONTAINED ELSEWHERE IN OUR ANNUAL REPORT AND SUBSEQUENT DOCUMENTS FILED WITH THE SEC IDENTIFIES OTHER FACTORS THAT COULD CAUSE DIFFERENCES FROM OUR FORWARD LOOKING STATEMENTS.  ALSO, OTHER IMPORTANT FACTORS THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY

 

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FROM THOSE IN OUR FORWARD LOOKING STATEMENTS ARE DESCRIBED MORE FULLY UNDER “RISK FACTORS” IN OUR ANNUAL REPORT AND OUR QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2010.

 

YOU SHOULD NOT PLACE UNDUE RELIANCE UPON OUR FORWARD LOOKING STATEMENTS.

 

EXCEPT AS REQUIRED BY LAW, WE DO NOT INTEND TO UPDATE OR CHANGE ANY FORWARD LOOKING STATEMENTS AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.

 

STATEMENT CONCERNING LIMITED LIABILITY

 

THE AMENDED AND RESTATED DECLARATION OF TRUST ESTABLISHING COMMONWEALTH REIT, DATED JULY 1, 1994, AS AMENDED AND SUPPLEMENTED, AS FILED WITH THE STATE DEPARTMENT OF ASSESSMENTS AND TAXATION OF MARYLAND, PROVIDES THAT NO TRUSTEE, OFFICER, SHAREHOLDER, EMPLOYEE OR AGENT OF COMMONWEALTH REIT SHALL BE HELD TO ANY PERSONAL LIABILITY, JOINTLY OR SEVERALLY, FOR ANY OBLIGATION OF, OR CLAIM AGAINST, COMMONWEALTH REIT.  ALL PERSONS DEALING WITH COMMONWEALTH REIT IN ANY WAY SHALL LOOK ONLY TO THE ASSETS OF COMMONWEALTH REIT FOR THE PAYMENT OF ANY SUM OR THE PERFORMANCE OF ANY OBLIGATION.

 

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Table of Contents

 

Part II.          Other Information

 

Item 1.           Legal Proceedings

 

On August 14, 2009, we commenced litigation in the U.S. District Court for the District of Hawaii to declare Hawaii state legislation which seeks to limit rent increases at certain of our leased industrial and commercial lands in Hawaii to be in violation of the United States Constitution.  In May 2010, the U.S. District Court in Hawaii ruled that the law intended to limit the rents we may charge violates the U.S. Constitution and is unenforceable and a judgment was entered in our favor on June 1, 2010.  During June 2010, the State of Hawaii appealed this judgment to the U.S. Court of Appeals for the 9th Circuit.  In October 2010, we entered a settlement agreement with the State of Hawaii pursuant to which the State’s appeal was dismissed with prejudice and we agreed not to seek recovery of our attorneys’ fees from the State.  Our settlement with the State preserves our ability to seek recovery of our attorneys’ fees from a tenants’ organization which sponsored this unconstitutional legislation and then intervened in this litigation.  We are now considering whether to pursue this claim for attorneys’ fees.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

As previously reported, on September 17, 2010, pursuant to our equity compensation plan, we granted an aggregate of 42,375 common shares of beneficial interest, par value $0.01 per share, valued at $27.30 per common share, the closing price of our common shares on the New York Stock Exchange on that day, to our officers and certain employees of our manager, Reit Management & Research LLC.  We made these grants pursuant to an exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended.

 

Item 5. Other Information

 

On October 29, 2010, we and RMR entered into an amendment to our business management agreement that provides that, beginning on the date that we completed our acquisition of MacarthurCook Industrial Property Fund, we will pay RMR a business management fee equal to 1.0% of the historical cost of properties we acquire located outside the United States, Puerto Rico or Canada.  However, RMR has agreed to waive half of this fee and half of the other fees payable by us under our property management agreement with RMR for so long as our business and property management agreement with MacarthurCook Fund Management Limited, or the MCK agreement, is in effect and we or any of our subsidiaries are paying the fees under that agreement.  The MCK agreement relates to the properties we acquired upon our acquisition of MacarthurCook Industrial Property Fund, which is more fully described elsewhere in this Report, as well as other properties which our Australian subsidiary may acquire from time to time.  The terms of the amendment to our business management agreement described above were reviewed, approved and adopted by our Compensation Committee of our Board of Trustees, which is comprised solely of Independent Trustees.

 

The foregoing description of the amendment to the business management agreement and the related waiver is not complete and is subject to and qualified in its entirety by reference to the amendment and the waiver, copies of which are attached as Exhibits 10.3 and 10.4, respectively, and are incorporated herein by reference.

 

One of our Managing Trustees, Barry M. Portnoy, is the Chairman and majority owner of RMR.  Our other Managing Trustee, Adam D. Portnoy, owns the remainder of RMR and is a director, President and Chief Executive Officer of RMR.  Our executive officers are also officers of RMR.  Further information regarding certain relationships and related transactions with respect to us, our Trustees and officers, RMR and certain other companies to which RMR provides management services, is contained in Item 2 of Part I of this Report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Related Person Transactions” and in our other filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (including the sections captioned “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Related Person Transactions”) and the Proxy Statement for the 2010 annual meeting of our shareholders (including the information regarding our Trustees and officers set forth therein and the section captioned “Related Person Transactions and Company Review of Such Transactions”).

 

Item 6.         Exhibits

 

4.1                                Supplemental Indenture No. 20, dated as of September 17, 2010, between the Company and U.S. Bank National Association relating to the Company’s 5.875% Senior Notes due 2020, including form thereof.  (filed herewith)

 

4.2                                Form of Common Share Certificate.  (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K dated September 17, 2010, filed with the SEC on September 20, 2010, File No. 001-09317)

 

4.3                                Form of 8¾% Series B Cumulative Redeemable Preferred Share Certificate.  (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K dated September 17, 2010, filed with the SEC on September 20, 2010, File No. 001-09317)

 

4.4                                Form of 71/8% Series C Cumulative Redeemable Preferred Share Certificate.  (Incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K dated September 17, 2010, filed with the SEC on September 20, 2010, File No. 001-09317)

 

4.5                                Form of 6½% Series D Cumulative Convertible Preferred Share Certificate.  (Incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K dated September 17, 2010, filed with the SEC on September 20, 2010, File No. 001-09317)

 

10.1                          Credit Agreement dated as of August 9, 2010 by and among CommonWealth REIT, Wells Fargo Bank, National Association, as Administrative Agent, Bank of America, N.A., as Syndication Agent, each of Regions Bank, Royal Bank of Canada and Sumitomo Mitsui Banking Corporation, as Documentation Agents, each of Wells Fargo Securities, LLC and Banc of America Securities LLC, as Joint Lead Arrangers and Joint Lead Bookrunners, and each of the financial institutions initially a signatory thereto together with their assignees.  (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated August 9, 2010, filed with the SEC on August 9, 2010, File No. 001-09317)

 

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10.2                          Second Amendment to Business Management Agreement, dated as of August 3, 2010, by and between CommonWealth REIT and Reit Management & Research LLC.  (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated August 9, 2010, filed with the SEC on August 9, 2010, File No. 001-09317)

 

10.3                          Third Amendment to Business Management Agreement, dated as of October 29, 2010, by and between CommonWealth REIT and Reit Management & Research LLC.  (filed herewith)

 

10.4                           Letter, dated October 29, 2010, from Reit Management & Research LLC to CommonWealth REIT. (filed herewith)

 

10.5                          Form of Restricted Share Agreement.  (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated September 17, 2010, filed with the SEC on September 20, 2010, File No. 001-09317)

 

12.1                          Computation of Ratio of Earnings to Fixed Charges. (filed herewith)

 

12.2                          Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Distributions. (filed herewith)

 

31.1                          Rule 13a-14(a) Certification. (filed herewith)

 

31.2                          Rule 13a-14(a) Certification. (filed herewith)

 

31.3                          Rule 13a-14(a) Certification. (filed herewith)

 

31.4                          Rule 13a-14(a) Certification. (filed herewith)

 

32.1                          Section 1350 Certification. (furnished herewith)

 

101.1                    The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Cash Flows and (iv) related notes to these financial statements, tagged as blocks of text. (furnished herewith)

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

COMMONWEALTH REIT

 

 

 

 

 

 

 

By:

/s/ John A. Mannix

 

 

John A. Mannix

 

 

President and Chief Investment Officer

 

 

Dated:  November 3, 2010

 

 

 

 

 

 

 

By:

/s/ John C. Popeo

 

 

John C. Popeo

 

 

Treasurer and Chief Financial Officer

 

 

(principal financial and accounting officer)

 

 

Dated:  November 3, 2010

 

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